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’. 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. We can see that BWX Technologies, Inc. (NYSE:BWXT) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.
How Much Debt Does BWX Technologies Carry?
The image below, which you can click on for greater detail, shows that at September 2019 BWX Technologies had debt of US$864.1m, up from US$771.2m in one year. Net debt is about the same, since the it doesn’t have much cash.
How Healthy Is BWX Technologies’s Balance Sheet?
According to the last reported balance sheet, BWX Technologies had liabilities of US$333.7m due within 12 months, and liabilities of US$1.14b due beyond 12 months. On the other hand, it had cash of US$17.3m and US$559.7m worth of receivables due within a year. So it has liabilities totalling US$895.0m more than its cash and near-term receivables, combined.
Given BWX Technologies has a market capitalization of US$6.26b, it’s hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
With net debt to EBITDA of 2.5 BWX Technologies has a fairly noticeable amount of debt. On the plus side, its EBIT was 7.8 times its interest expense, and its net debt to EBITDA, was quite high, at 2.5. Sadly, BWX Technologies’s EBIT actually dropped 8.4% in the last year. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. 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 BWX Technologies 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, BWX Technologies’s free cash flow amounted to 33% of its EBIT, less than we’d expect. That’s not great, when it comes to paying down debt.
While BWX Technologies’s conversion of EBIT to free cash flow makes us cautious about it, its track record of (not) growing its EBIT is no better. But its not so bad at covering its interest expense with its EBIT. Looking at all the angles mentioned above, it does seem to us that BWX Technologies is a somewhat risky investment as a result of its debt. That’s not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet – far from it. Consider for instance, the ever-present spectre of investment risk. We’ve identified 1 warning sign with BWX Technologies , and understanding them should be part of your investment process.
At the end of the day, it’s often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It’s free.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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