These 4 Measures Indicate That Hunting (LON:HTG) Is Using Debt Reasonably Well

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Hunting PLC (LON:HTG) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Hunting

How Much Debt Does Hunting Carry?

The image below, which you can click on for greater detail, shows that at June 2023 Hunting had debt of US$92.1m, up from US$5.40m in one year. On the flip side, it has US$36.5m in cash leading to net debt of about US$55.6m.

How Strong Is Hunting's Balance Sheet?

We can see from the most recent balance sheet that Hunting had liabilities of US$256.1m falling due within a year, and liabilities of US$37.0m due beyond that. Offsetting this, it had US$36.5m in cash and US$255.0m in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.

Having regard to Hunting's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$591.2m company is struggling for cash, we still think it's worth monitoring its balance sheet.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Hunting's net debt is only 0.85 times its EBITDA. And its EBIT easily covers its interest expense, being 10.3 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. It was also good to see that despite losing money on the EBIT line last year, Hunting turned things around in the last 12 months, delivering and EBIT of US$35m. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Hunting'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, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Hunting saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Hunting's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. When we consider all the factors mentioned above, we do feel a bit cautious about Hunting's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Hunting (1 can't be ignored!) that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.