Howard Marks put it nicely when he said that, rather than worrying about share price volatility, ‘The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Custom Truck One Source, Inc. (NYSE:CTOS) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Custom Truck One Source’s Debt?
The image below, which you can click on for greater detail, shows that at September 2021 Custom Truck One Source had debt of US$1.58b, up from US$742.4m in one year. Net debt is about the same, since the it doesn’t have much cash.
How Strong Is Custom Truck One Source’s Balance Sheet?
We can see from the most recent balance sheet that Custom Truck One Source had liabilities of US$416.6m falling due within a year, and liabilities of US$1.41b due beyond that. On the other hand, it had cash of US$21.1m and US$191.1m worth of receivables due within a year. So it has liabilities totalling US$1.61b more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of US$1.98b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Custom Truck One Source’s ability to maintain a healthy balance sheet going forward.
Over 12 months, Custom Truck One Source reported revenue of US$894m, which is a gain of 201%, although it did not report any earnings before interest and tax. That’s virtually the hole-in-one of revenue growth!
While we can certainly appreciate Custom Truck One Source’s revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. To be specific the EBIT loss came in at US$2.7m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. For example, we would not want to see a repeat of last year’s loss of US$185m. So we do think this stock is quite risky. The balance sheet is clearly the area to focus on when you are analysing debt.