Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that CNX Resources Corporation (NYSE:CNX) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does CNX Resources Carry?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 CNX Resources had US$2.62b of debt, an increase on US$2.35b, over one year. Net debt is about the same, since the it doesn't have much cash.
How Healthy Is CNX Resources's Balance Sheet?
According to the last reported balance sheet, CNX Resources had liabilities of US$623.2m due within 12 months, and liabilities of US$3.42b due beyond 12 months. Offsetting these obligations, it had cash of US$32.6m as well as receivables valued at US$250.3m due within 12 months. So its liabilities total US$3.76b more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the US$1.34b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt At the end of the day, CNX Resources would probably need a major re-capitalization if its creditors were to demand repayment.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
CNX Resources has a debt to EBITDA ratio of 2.6 and its EBIT covered its interest expense 3.3 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Looking on the bright side, CNX Resources boosted its EBIT by a silky 37% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if CNX Resources can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last two years, CNX Resources burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
To be frank both CNX Resources's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at growing its EBIT; that's encouraging. Overall, it seems to us that CNX Resources's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. Given our hesitation about the stock, it would be good to know if CNX Resources insiders have sold any shares recently. You click here to find out if insiders have sold recently.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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