We Think Hammond Power Solutions (TSE:HPS.A) Can Stay On Top Of Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We note that Hammond Power Solutions Inc. (TSE:HPS.A) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Hammond Power Solutions

How Much Debt Does Hammond Power Solutions Carry?

As you can see below, at the end of March 2024, Hammond Power Solutions had CA$23.0m of debt, up from CA$12.6m a year ago. Click the image for more detail. However, its balance sheet shows it holds CA$53.9m in cash, so it actually has CA$30.9m net cash.

A Look At Hammond Power Solutions' Liabilities

We can see from the most recent balance sheet that Hammond Power Solutions had liabilities of CA$172.5m falling due within a year, and liabilities of CA$11.9m due beyond that. On the other hand, it had cash of CA$53.9m and CA$141.9m worth of receivables due within a year. So it can boast CA$11.3m more liquid assets than total liabilities.

Having regard to Hammond Power Solutions' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CA$1.26b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Hammond Power Solutions boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Hammond Power Solutions grew its EBIT by 5.8% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Hammond Power Solutions's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Hammond Power Solutions may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Hammond Power Solutions's free cash flow amounted to 42% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Hammond Power Solutions has net cash of CA$30.9m, as well as more liquid assets than liabilities. On top of that, it increased its EBIT by 5.8% in the last twelve months. So we are not troubled with Hammond Power Solutions's debt use. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Hammond Power Solutions insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com