We believe Air Transport Services Group (NASDAQ: ATSG) is taking risks with its debt

Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss. of capital “. So it can be obvious that you need to consider debt, when you think about how risky a given stock is, because too much debt can sink a business. Above all, Airline Services Group, Inc. (NASDAQ: ATSG) is in debt. But should shareholders be concerned about its use of debt?

When Is Debt a Problem?

Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. When we think of a business’s use of debt, we first look at cash flow and debt together.

See our latest analysis for Air Transport Services Group

What is the net debt of the air transport services group?

As you can see below, Air Transport Services Group had a debt of US $ 1.38 billion in September 2021, up from US $ 1.48 billion the year before. However, given that it has a cash reserve of US $ 49.8 million, its net debt is less, at around US $ 1.33 billion.

NasdaqGS: History of debt to equity of ATSG December 1, 2021

A look at the responsibilities of the Air Transport Services Group

The latest balance sheet data shows that Air Transport Services Group had liabilities of US $ 285.8 million due within one year, and liabilities of US $ 1.75 billion due thereafter. In return, he had $ 49.8 million in cash and $ 191.7 million in receivables due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by US $ 1.80 billion.

This deficit is sizable compared to its market capitalization of US $ 1.82 billion, so he suggests shareholders keep an eye on the use of Air Transport Services Group debt. This suggests that shareholders would be heavily diluted if the company needed to consolidate its balance sheet quickly.

In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). Thus, we consider debt versus earnings with and without amortization expenses.

The Air Transport Services Group’s debt is 2.6 times its EBITDA, and its EBIT covers its interest expense 3.7 times. Overall, this implies that while we wouldn’t like to see debt levels rise, we believe it can handle its current leverage. Unfortunately, Air Transport Services Group has seen its EBIT fall by 3.7% over the past twelve months. If this earnings trend continues, its debt load will rise like the heart of a polar bear watching its only cub. There is no doubt that we learn the most about debt from the balance sheet. But it is future profits, more than anything, that will determine Air Transport Services Group’s ability to maintain a healthy balance sheet going forward. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, a business needs free cash flow to repay its debts; accounting profits are not enough. It is therefore worth checking to what extent this EBIT is supported by free cash flow. In view of the past three years, Air Transport Services Group has effectively recorded an overall cash outflow. Debt is much riskier for companies with unreliable free cash flow, so shareholders should hope that past spending will produce free cash flow in the future.

Our point of view

Reflecting on Air Transport Services Group’s attempt to convert EBIT into free cash flow, we are certainly not enthusiastic. But at least his net debt to EBITDA isn’t that bad. We are pretty clear that we consider Air Transport Services Group to be really quite risky, because of the health of its balance sheet. We are therefore almost as wary of this stock as a hungry kitten falls into its owner’s fish pond: once bitten, twice shy, as they say. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. Concrete example: we have spotted 4 warning signs for Air Transport Services Group you have to be aware of that, and one of them makes us a little uncomfortable.

At the end of the day, it’s often best to focus on businesses that don’t have net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.

Do you have any feedback on this item? Are you worried about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.

Comments are closed.