David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Hill-Rom Holdings, Inc. (NYSE:HRC) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Hill-Rom Holdings’s Debt?
The image below, which you can click on for greater detail, shows that Hill-Rom Holdings had debt of US$2.07b at the end of June 2019, a reduction from US$2.17b over a year. However, it does have US$202.6m in cash offsetting this, leading to net debt of about US$1.87b.
A Look At Hill-Rom Holdings’s Liabilities
Zooming in on the latest balance sheet data, we can see that Hill-Rom Holdings had liabilities of US$814.2m due within 12 months and liabilities of US$2.14b due beyond that. On the other hand, it had cash of US$202.6m and US$597.9m worth of receivables due within a year. So it has liabilities totalling US$2.15b more than its cash and near-term receivables, combined.
Hill-Rom Holdings has a market capitalization of US$7.05b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it’s clear that we should definitely closely examine whether it can manage its debt without dilution.
We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Hill-Rom Holdings’s debt is 3.3 times its EBITDA, and its EBIT cover its interest expense 4.3 times over. This suggests that while the debt levels are significant, we’d stop short of calling them problematic. The good news is that Hill-Rom Holdings improved its EBIT by 7.7% over the last twelve years, thus gradually reducing its debt levels relative to its earnings. 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 Hill-Rom Holdings can strengthen its balance sheet over time. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it’s worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Hill-Rom Holdings recorded free cash flow worth 76% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
The good news is that Hill-Rom Holdings’s demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But truth be told we feel its net debt to EBITDA does undermine this impression a bit. It’s also worth noting that Hill-Rom Holdings is in the Medical Equipment industry, which is often considered to be quite defensive. All these things considered, it appears that Hill-Rom Holdings can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it’s worth keeping an eye on this one. Over time, share prices tend to follow earnings per share, so if you’re interested in Hill-Rom Holdings, you may well want to click here to check an interactive graph of its earnings per share history.
If, after all that, you’re more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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