Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies The Goodyear Tire & Rubber Company (NASDAQ:GT) makes use of debt. But the real question is whether this debt is making the company risky.
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together. Roller Skating Tiles Outdoor
Check out our latest analysis for Goodyear Tire & Rubber
As you can see below, at the end of June 2023, Goodyear Tire & Rubber had US$8.56b of debt, up from US$8.15b a year ago. Click the image for more detail. However, it also had US$1.05b in cash, and so its net debt is US$7.51b.
Zooming in on the latest balance sheet data, we can see that Goodyear Tire & Rubber had liabilities of US$6.94b due within 12 months and liabilities of US$10.6b due beyond that. Offsetting this, it had US$1.05b in cash and US$3.02b in receivables that were due within 12 months. So it has liabilities totalling US$13.5b more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the US$3.67b 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 definitely think shareholders need to watch this one closely. After all, Goodyear Tire & Rubber would likely require a major re-capitalisation if it had to pay its creditors today.
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.
Goodyear Tire & Rubber shareholders face the double whammy of a high net debt to EBITDA ratio (5.5), and fairly weak interest coverage, since EBIT is just 0.89 times the interest expense. This means we'd consider it to have a heavy debt load. Worse, Goodyear Tire & Rubber's EBIT was down 65% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Goodyear Tire & Rubber 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. Over the last three years, Goodyear Tire & Rubber reported free cash flow worth 9.9% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.
On the face of it, Goodyear Tire & Rubber's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And even its net debt to EBITDA fails to inspire much confidence. Considering all the factors previously mentioned, we think that Goodyear Tire & Rubber really is carrying too much debt. To our minds, that means the stock is rather high risk, and probably one to avoid; but to each their own (investing) style. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - Goodyear Tire & Rubber has 1 warning sign we think you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
Find out whether Goodyear Tire & Rubber is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.
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The Goodyear Tire & Rubber Company, together with its subsidiaries, develops, manufactures, distributes, and sells tires and related products and services worldwide.
Undervalued with moderate growth potential.
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