Is Truck-One (FKSE:3047) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway’s Charlie Munger, Li Lu, makes no bones about it when he says ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.’ 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. As with many other companies Truck-One Co., Ltd. (FKSE:3047) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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.

Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return.

When we think about a company’s use of debt, we first look at cash and debt together. View our latest analysis for Truck-One

What Is Truck-One’s Debt?

As you can see below, Truck-One had JP?1.55b of debt at June 2020, down from JP?1.66b a year prior. However, it does have JP?379.0m in cash offsetting this, leading to net debt of about JP?1.17b.

debt-equity-history-analysisFKSE:3047 Debt to Equity History September 19th 2020

How Healthy Is Truck-One’s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Truck-One had liabilities of JP?2.72b due within 12 months and liabilities of JP?138.0m due beyond that.

On the other hand, it had cash of JP?379.0m and JP?187.0m worth of receivables due within a year. So it has liabilities totalling JP?2.29b more than its cash and near-term receivables, combined. The deficiency here weighs heavily on the JP?568.5m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet.

So we definitely think shareholders need to watch this one closely. At the end of the day, Truck-One 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). Truck-One has a rather high debt to EBITDA ratio of 6.4 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 3.3 times, suggesting it can responsibly service its obligations.

Worse, Truck-One’s EBIT was down 81% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start.

But you can’t view debt in total isolation; since Truck-One will need earnings to service that debt. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot. Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash.

So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Truck-One burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Truck-One’s EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels.

And even its net debt to EBITDA fails to inspire much confidence. It looks to us like Truck-One carries a significant balance sheet burden. If you harvest honey without a bee suit, you risk getting stung, so we’d probably stay away from this particular stock.

The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it. For instance, we’ve identified 5 warning signs for Truck-One (2 are a bit concerning) you should be aware of.

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. Promoted
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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data.

Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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