Hexagon Composites (OB:HEX) Has A Somewhat Strained Balance Sheet
Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Hexagon Composites ASA (OB:HEX) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for Hexagon Composites
What Is Hexagon Composites's Net Debt?
The image below, which you can click on for greater detail, shows that Hexagon Composites had debt of kr1.09b at the end of June 2024, a reduction from kr1.78b over a year. However, because it has a cash reserve of kr335.7m, its net debt is less, at about kr753.0m.
How Strong Is Hexagon Composites' Balance Sheet?
We can see from the most recent balance sheet that Hexagon Composites had liabilities of kr1.04b falling due within a year, and liabilities of kr1.87b due beyond that. Offsetting these obligations, it had cash of kr335.7m as well as receivables valued at kr528.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr2.05b.
Hexagon Composites has a market capitalization of kr7.67b, 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.
While Hexagon Composites has a quite reasonable net debt to EBITDA multiple of 1.8, its interest cover seems weak, at 0.71. In large part that's it has so much depreciation and amortisation. These charges may be non-cash, so they could be excluded when it comes to paying down debt. But the accounting charges are there for a reason -- some assets are seen to be losing value. Either way there's no doubt the stock is using meaningful leverage. Importantly, Hexagon Composites grew its EBIT by 39% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Hexagon Composites 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Hexagon Composites burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Our View
Hexagon Composites's conversion of EBIT to free cash flow and interest cover definitely weigh on it, in our esteem. But the good news is it seems to be able to grow its EBIT with ease. We think that Hexagon Composites's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. Be aware that Hexagon Composites is showing 1 warning sign in our investment analysis , you should know about...
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.
Valuation is complex, but we're here to simplify it.
Discover if Hexagon Composites might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.
Access Free AnalysisHave feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
About OB:HEX
Hexagon Composites
Engages in the manufacture and sale of composite pressure cylinders and fuel systems for alternative fuels worldwide.
Good value with reasonable growth potential.