Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies The ODP Corporation (NASDAQ:ODP) makes use of debt. 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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.
Check out our latest analysis for ODP
How Much Debt Does ODP Carry?
You can click the graphic below for the historical numbers, but it shows that ODP had US$280.0m of debt in June 2020, down from US$1.38b, one year before. But on the other hand it also has US$762.0m in cash, leading to a US$482.0m net cash position.
A Look At ODP’s Liabilities
The latest balance sheet data shows that ODP had liabilities of US$2.14b due within a year, and liabilities of US$2.01b falling due after that. Offsetting this, it had US$762.0m in cash and US$698.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$2.69b.
The deficiency here weighs heavily on the US$1.11b 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’d watch its balance sheet closely, without a doubt. At the end of the day, ODP would probably need a major re-capitalization if its creditors were to demand repayment. Given that ODP has more cash than debt, we’re pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.
Unfortunately, ODP saw its EBIT slide 5.7% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine ODP’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 report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. ODP may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, ODP generated free cash flow amounting to a very robust 94% of its EBIT, more than we’d expect. That positions it well to pay down debt if desirable to do so.
Summing up
While ODP does have more liabilities than liquid assets, it also has net cash of US$482.0m. The cherry on top was that in converted 94% of that EBIT to free cash flow, bringing in US$445m. So while ODP does not have a great balance sheet, it’s certainly not too bad. Even though ODP lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check out how earnings have been trending over the last few years.
At the end of the day, it’s often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It’s free.
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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