Here's Why Adient (NYSE:ADNT) Has A Meaningful Debt Burden

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Adient plc (NYSE:ADNT) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Adient

What Is Adient's Debt?

As you can see below, Adient had US$2.54b of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has US$1.11b in cash leading to net debt of about US$1.43b.

A Look At Adient's Liabilities

According to the last reported balance sheet, Adient had liabilities of US$3.74b due within 12 months, and liabilities of US$3.08b due beyond 12 months. Offsetting this, it had US$1.11b in cash and US$1.98b in receivables that were due within 12 months. So it has liabilities totalling US$3.73b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's US$3.21b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Adient's net debt is sitting at a very reasonable 1.8 times its EBITDA, while its EBIT covered its interest expense just 2.7 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Notably, Adient's EBIT launched higher than Elon Musk, gaining a whopping 109% on last year. 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 Adient's ability to maintain a healthy balance sheet going forward. 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Adient's free cash flow amounted to 49% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Adient's level of total liabilities 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. Looking at all the angles mentioned above, it does seem to us that Adient is a somewhat risky investment as a result of its debt. 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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Adient (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

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.