We think General Motors (NYSE: GM) is taking risks with its debt
Warren Buffett said: “Volatility is far from synonymous with risk”. 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. We notice that General Motors Company (NYSE: GM) has debt on its balance sheet. But does this debt worry shareholders?
Why Does Debt Bring Risk?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. If things really go wrong, lenders can take over the business. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. Of course, debt can be an important tool in businesses, especially capital intensive businesses. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
Check out our latest analysis for General Motors
What is General Motors’ net debt?
As you can see below, General Motors had $ 110.8 billion in debt in March 2021, up from $ 127.0 billion the year before. However, it has $ 23.1 billion in cash offsetting that, leading to net debt of around $ 87.7 billion.
How strong is General Motors’ balance sheet?
We can see from the most recent balance sheet that General Motors had liabilities of US $ 76.3 billion maturing within one year and liabilities of US $ 107.6 billion maturing beyond that. . In compensation for these obligations, it had cash of US $ 23.1 billion as well as receivables valued at US $ 9.13 billion due within 12 months. It therefore has liabilities totaling $ 151.8 billion more than its cash and short-term receivables combined.
The lack here weighs heavily on the $ 91.9 billion business itself, as if a child struggles under the weight of a huge backpack full of books, his gym equipment and a trumpet. . So we would be watching its record closely, without a doubt. After all, General Motors would likely need a major recapitalization if it were to pay its creditors today.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Oddly enough, General Motors has a very high EBITDA ratio of 5.5, which implies high debt, but high interest coverage of 11.2. This means that unless the business has access to very cheap debt, these interest charges will likely increase in the future. It should be noted that General Motors’ EBIT has soared like bamboo after the rain, gaining 57% in the past twelve months. This will make it easier to manage your debt. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether General Motors can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, General Motors has spent a lot of money. While investors no doubt expect this situation to reverse in due course, it clearly means that its use of debt is riskier.
Our point of view
To be frank, General Motors’ conversion of EBIT to free cash flow and its history of staying on top of its total liabilities makes us rather uncomfortable with its debt levels. But on the positive side, its EBIT growth rate is a good sign and makes us more optimistic. Overall, we think it’s fair to say that General Motors has enough debt that there is real risk around the balance sheet. If all goes well, this should increase returns, but on the other hand, the risk of permanent capital loss is increased by debt. The balance sheet is clearly the area you need to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. Concrete example: we have spotted 1 warning sign for General Motors you must be aware.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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