These 4 measures indicate that Greif (NYSE:GEF) is using debt reasonably well

Warren Buffett said: “Volatility is far from synonymous with risk. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Above all, Greif, Inc. (NYSE:GEF) is in debt. But the more important question is: what risk does this debt create?

When is debt dangerous?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. If things go really bad, lenders can take over the business. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.

See our latest analysis for Greif

What is Greif’s net debt?

You can click on the chart below for historical numbers, but it shows Greif had $2.30 billion in debt in January 2022, up from $2.55 billion a year prior. However, since he has a cash reserve of $119.7 million, his net debt is less, at around $2.18 billion.

NYSE: WEF Debt to Equity History April 10, 2022

A look at Greif’s responsibilities

We can see from the most recent balance sheet that Greif had liabilities of US$1.28 billion due in one year, and liabilities of US$2.91 billion due beyond. In return, he had $119.7 million in cash and $816.1 million in receivables due within 12 months. It therefore has liabilities totaling $3.25 billion more than its cash and short-term receivables, combined.

When you consider that shortfall exceeds the company’s US$2.95 billion market capitalization, you might well be inclined to take a close look at the balance sheet. In the scenario where the company were to quickly clean up its balance sheet, it seems likely that shareholders would suffer significant dilution.

We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

Greif has a debt to EBITDA ratio of 2.6 and its EBIT covered its interest expense 7.0 times. This suggests that while debt levels are significant, we will refrain from labeling them as problematic. Importantly, Greif has grown its EBIT by 52% over the past twelve months, and this growth will make it easier to manage its 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 Greif can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Greif has produced strong free cash flow equivalent to 56% of its EBIT, which is what we expected. This free cash flow puts the company in a good position to repay its debt, should it arise.

Our point of view

Looking at the balance sheet, the biggest positive for Greif is the fact that it looks like it can grow its EBIT with confidence. But the other factors we noted above weren’t so encouraging. In particular, the level of total liabilities gives us chills. Looking at all this data, we feel a bit cautious about Greif’s debt levels. While we understand that debt can improve returns on equity, we suggest shareholders keep a close eye on their level of debt, lest it increase. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. We have identified 1 warning sign with Greif, and understanding them should be part of your investment process.

Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.

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

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