Howard Marks put it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried. It is only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. We can see that Herc Holdings Inc. (NYSE: HRI) uses debt in its business. But does this debt worry shareholders?
When is debt dangerous?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first step in examining a business’s debt levels is to consider its cash flow and debt together.
Check out our latest analysis for Herc Holdings
What is the net debt of Herc Holdings?
As you can see below, Herc Holdings was in debt of $ 1.87 billion, as of September 2021, which is roughly the same as the year before. You can click on the graph for more details. Net debt is about the same because it doesn’t have a lot of cash.
How strong is Herc Holdings’ balance sheet?
The latest balance sheet data shows Herc Holdings had liabilities of $ 426.7 million due within one year, and liabilities of $ 2.80 billion due thereafter. In return, he had $ 35.2 million in cash and $ 373.7 million in receivables due within 12 months. Thus, its liabilities exceed the sum of its cash and its (short-term) receivables by $ 2.81 billion.
This deficit is sizable compared to its market cap of US $ 4.64 billion, so he suggests shareholders keep an eye on Herc Holdings’ use of debt. If its lenders asked it to consolidate the balance sheet, shareholders would likely face severe dilution.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). Thus, we look at debt versus earnings with and without amortization expenses.
Herc Holdings’ debt is 4.6 times its EBITDA, and its EBIT covers its interest expense 3.8 times. This suggests that while debt levels are significant, we would stop calling them problematic. Looking on the bright side, Herc Holdings has grown its EBIT silky 54% over the past year. Like a mother’s loving embrace of a newborn, this type of growth builds resilience, putting the business in a stronger position to manage debt. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Herc Holdings 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.
Finally, a business can only pay off its debts with hard cash, not with book profits. 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, Herc Holdings has generated free cash flow of 99% of its very robust EBIT, more than we expected. This puts him in a very strong position to pay off the debt.
Our point of view
The good news is that Herc Holdings’ demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But we have to admit that we find that its net debt to EBITDA has the opposite effect. Looking at all of the above factors together, it seems to us that Herc Holdings can manage its debt quite comfortably. Of course, while this leverage can improve returns on equity, it comes with more risk, so it’s worth keeping an eye out for. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we have identified 3 warning signs for Herc Holdings that you need to be aware of.
If you want to invest in companies that can generate profits without the burden of debt, check out this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.