Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.’ 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. We note that Green Thumb Industries Inc. (CSE:GTII) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. The first step when considering a company’s debt levels is to consider its cash and debt together.
View our latest analysis for Green Thumb Industries
What Is Green Thumb Industries’s Debt?
The image below, which you can click on for greater detail, shows that at March 2023 Green Thumb Industries had debt of US$277.8m, up from US$244.2m in one year. However, it does have US$185.4m in cash offsetting this, leading to net debt of about US$92.5m.
How Strong Is Green Thumb Industries’ Balance Sheet?
We can see from the most recent balance sheet that Green Thumb Industries had liabilities of US$186.9m falling due within a year, and liabilities of US$625.1m due beyond that. On the other hand, it had cash of US$185.4m and US$31.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$595.7m.
This deficit isn’t so bad because Green Thumb Industries is worth US$1.75b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Green Thumb Industries’s net debt is only 0.31 times its EBITDA. And its EBIT easily covers its interest expense, being 14.3 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the bad news is that Green Thumb Industries has seen its EBIT plunge 11% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Green Thumb Industries can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Considering the last three years, Green Thumb Industries actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
Our View
We feel some trepidation about Green Thumb Industries’s difficulty conversion of EBIT to free cash flow, but we’ve got positives to focus on, too. For example, its interest cover and net debt to EBITDA give us some confidence in its ability to manage its debt. We think that Green Thumb Industries’s debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. While Green Thumb Industries didn’t make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away. Click here to see if its earnings are heading in the right direction, over the medium term.
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