Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Like many other companies Hillenbrand, Inc. (NYSE:HI) uses debt. But the real question is whether this debt makes the business risky.
When is debt dangerous?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. 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 thing to do when considering how much debt a business has is to look at its cash and debt together.
See our latest analysis for Hillenbrand
What is Hillenbrand’s net debt?
You can click on the chart below for historical numbers, but it shows Hillenbrand had $1.21 billion in debt in December 2021, up from $1.40 billion a year prior. However, he has $447.4 million in cash to offset this, resulting in a net debt of approximately $766.0 million.
How healthy is Hillenbrand’s balance sheet?
We can see from the most recent balance sheet that Hillenbrand had liabilities of US$1.03 billion due in one year, and liabilities of US$1.71 billion due beyond. On the other hand, it had liquid assets of 447.4 million dollars and 446.4 million dollars of receivables within one year. It therefore has liabilities totaling $1.85 billion more than its cash and short-term receivables, combined.
This is a mountain of leverage compared to its market capitalization of US$3.01 billion. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
While Hillenbrand’s low debt-to-EBITDA ratio of 1.4 suggests only modest debt utilization, the fact that EBIT only covered interest expense by 5.9 times last year makes us reflect. But the interest payments are certainly enough to make us think about the affordability of its debt. One way for Hillenbrand to overcome its debt would be to stop borrowing more but continue to grow EBIT by around 12%, as it did last year. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Hillenbrand can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Hillenbrand has recorded free cash flow of 92% of its EBIT, which is higher than what we would normally expect. This puts him in a very strong position to pay off the debt.
Our point of view
The good news is that Hillenbrand’s demonstrated ability to convert EBIT into free cash flow delights us like a fluffy puppy does a toddler. But truth be told, we think his total passive level undermines that impression a bit. All told, it looks like Hillenbrand can comfortably handle his current level of debt. Of course, while this leverage can improve return on equity, it comes with more risk, so it’s worth keeping an eye out for. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. We have identified 2 warning signs with Hillenbrand, and understanding them should be part of your investment process.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeright now.
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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.