I like to keep a close eye on the developments of the auctioneer industry. Sometimes, I come across interesting investment options, like Ritchie Bros. Auctioneers Inc. (RBA). Although I take many aspects into account when I analyze a company, I will focus, in this article, on debt and liabilities, in addition to examining what analysts and other top investors think about this company.
This analysis is crucial to understanding the risks of investing, and will allow us to appreciate how leveraged the auctioneer is, and what kind of returns to expect from a long-term investment after the company reported its earnings last Monday. As the years 2008 and 2009 have taught us, leveraged companies with large amounts of debt can have a devastating impact over your investment. However, by taking a close look into the debt scheme of Auctioneers, we will be able to elucidate if the company is likely to maintain its capital, and use it for future growth.
As the world’s largest auctioneer of industrial and agricultural equipment, this company owns over 40 auction sites in 14 countries and counts on 1,400 employees. Its focus lies on unreserved public auctions, where the product is sold to the highest bidder, and the domestic market represents half of the company’s auction proceeds. Furthermore, the firm enjoys a wide economic moat due to its network effect. So, let’s take a look at the debt side of things and see where this industry giant is headed.
For the three months ended on December 31st, 2013, Ritchie Bros. reported net earnings of $0.31 per diluted share. This implies a 53% increase compared to net earnings of $0.21 per diluted share, reported for the same quarter last year. Revenues also grew, year-over-year, by 12%, to a record $131.2 million, compared to $117.1 in 2012.
Total Debt to Total Assets Ratio
This is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt. Calculated by adding short-term and long-term debt and then dividing this figure by the company's total assets, when the ratio is greater than 1, it indicates that a company has more total debt than assets; meanwhile, a debt ratio of less than 1 indicates that a company has more assets than total debt. Used along with other measures of financial health, the total debt to total assets ratio can help investors determine a company's level of risk.
Ritchie Bros' total debt to total assets ratio has increased from 0.20 to 0.29 over the past three years, meaning that since 2010, the firm has acquired more debt than it has increased the value of its assets. This is certainly a warning sign for bond investors.
However, given that the ratio of 0.29 is smaller than 1, the financial risk faced by the company is relatively low: its assets’ value comfortably surpasses its total debt levels.
Debt ratio = Total Liabilities / Total Assets
The debt ratio shows the proportion of a company's assets that is financed through debt. If the ratio is less than 0.5, most of the company's assets are financed through equity, while if above 0.5, the company's assets will be financed through debt. Companies with high debt/asset ratios are said to be "highly leveraged" and could be in danger if creditors start to demand repayment of debt.
When looking at Ritchie Bros’ debt ratio over the past three years, we can see that it has, in fact, increased from 0.33 to 0.41. Furthermore, the fact that the 2013 TTM ratio is below the 0.50 mark, indicates that the company has financed most of its assets through equity, which is a good sign.
One of the factors in favour of Ritchie Bros’ is its vast network of auction sites across North America. In addition to selling more used equipment than any of its competitors, the company also owns an online bidding site, EquipmentOne, which accounts for 33% of overall auctions. This network has allowed the company to generate average returns on invested capital of 17% over the past decade, surpassing the cost of capital.
Despite some weakness in ROIC levels over the past years, due to the lack of equipment produced during the 2009 recession, profitability should return to its normal rate as the economy regains pace. Furthermore, the buyer’s fee incorporated in 2011 has helped improved the firm’s core auction rate at a steady pace and will continue to generate profits in the long term.
Debt-to-Equity Ratio = Total Liabilities / Shareholders' Equity
The debt-to-equity ratio is another leverage ratio that compares a company's total liabilities with its total shareholders' equity. This measures how much suppliers, lenders, creditors and obligators have committed to the company versus what the shareholders have committed. A high debt-to-equity ratio generally means that a company has been aggressive in financing its growth with debt, resulting in the company reporting volatile earnings. It also indicates that a company may not be able to generate enough cash to satisfy its debt obligations, and therefore is considered a riskier investment.
I usually like companies with very low debt-to-equity ratios and conservative balance sheets. On the contrary, Ritchie Bros' debt-to-equity ratio has escalated from 0.50 in 2011 to 0.72 in 2013. As the company’s ratio for 2013 stands at 0.72, under the 1x mark, the risk for the company is quite low. This figure also implies that shareholders have invested less than suppliers, lenders, creditors and obligators.
Capitalization Ratio = LT Debt / LT Debt + Shareholders' Equity
(LT Debt = Long-Term Debt)
This ratio tells investors the extent to which the company is using its equity to support operations and growth, thereby helping in the assessment of risk. Companies with a high capitalization ratio are considered to be risky: if they fail to repay their debt on time, jeopardy of insolvency gets high, causing difficulties to get more loans in the future.
Over the past three years, Auctioneers’ capitalization ratio has increased, from 0.19 in 2011 to 0.23 in 2013, implying that the company has less equity compared with its long-term debt. As this is the case, the company has had less equity to support its operations and add growth through its equity. Given that as the ratio increases, so does the risk for the company, standing at 0.23 the financial risk for this auctioneer is merely moderate.
Cash Flow to Total Debt Ratio = Operating Cash Flow / Total Debt
This coverage ratio compares a company's operating cash flow with its total debt, thereby indicating a firm's ability to cover total debt with its yearly cash flow from operations. The larger the ratio, the better a company can weather rough economic conditions.
As the ratio stands below 1x, the company does not have the ability to cover its total debt with its yearly cash flow from operations. The ideal is finding stocks that have ratios well above 1.
I also look at which hedge funds bought the stock in the recent quarters. These past months, both Joel Greenblatt (Trades, Portfolio) and John Keeley (Trades, Portfolio) among other investment gurus added over 60% more of Ritchie Bros.’ company shares to their portfolios, at an average price of $20.61.
Several analysts expect Ritchie Bros to perform well over the upcoming years. The Yahoo! Finance team, for example, expects the firm to retrieve EPS of $0.90 for the current fiscal year and an EPS of $1.03 for the next fiscal year. On the other hand, they estimate that revenue will reach $484.26M for the current fiscal year and $516.65M for the next one. On Feb. 4th, research firm Cantor Fitzgerald upgraded Ritchie Bros. to a "Hold" rating, with a target price of $22.00, which implies no upside potential from this point.
After analyzing the company’s debt status, it’s clear that the balance sheet experienced some damage after the 2009 recession, putting pressure on margins and debt. However, Ritchie Bros’ returns on capital remain stable, as well as the 2.20% dividend yield, which should be attractive features for investors looking for profits. Also, the company’s wide economic moat is favourable and should guarantee a sense of stability in the future. In addition to this, the firm’s focus on providing the best market-price for its products should help retain customers. Despite the fact that the market doesn’t value the stock very much at the time, the company looks strong and established to me.
Disclosure: Vanina Egea holds no position in any stocks mentioned