These 4 Measures Indicate That Harley-Davidson (NYSE:HOG) Is Using Debt Reasonably Well

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 can see that Harley-Davidson, Inc. (NYSE:HOG) does use debt in its business. 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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Harley-Davidson

How Much Debt Does Harley-Davidson Carry?

The image below, which you can click on for greater detail, shows that Harley-Davidson had debt of US$6.89b at the end of December 2021, a reduction from US$8.99b over a year. On the flip side, it has US$1.08b in cash leading to net debt of about US$5.81b.

How Healthy Is Harley-Davidson's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Harley-Davidson had liabilities of US$3.34b due within 12 months and liabilities of US$5.15b due beyond that. On the other hand, it had cash of US$1.08b and US$182.1m worth of receivables due within a year. So it has liabilities totalling US$7.24b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of US$6.18b, we think shareholders really should watch Harley-Davidson's debt levels, like a parent watching their child ride a bike for the first time. 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.

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.

As it happens Harley-Davidson has a fairly concerning net debt to EBITDA ratio of 5.8 but very strong interest coverage of 34.5. So either it has access to very cheap long term debt or that interest expense is going to grow! Pleasingly, Harley-Davidson is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 509% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Harley-Davidson 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. Over the last three years, Harley-Davidson actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Both Harley-Davidson's ability to to cover its interest expense with its EBIT and its conversion of EBIT to free cash flow gave us comfort that it can handle its debt. But truth be told its net debt to EBITDA had us nibbling our nails. Considering this range of data points, we think Harley-Davidson is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. Be aware that Harley-Davidson is showing 3 warning signs in our investment analysis , and 1 of those is potentially serious...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

Have 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.