Stock Analysis

We Think Hudson Technologies (NASDAQ:HDSN) Is Taking Some Risk With Its Debt

NasdaqCM:HDSN
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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 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. Importantly, Hudson Technologies, Inc. (NASDAQ:HDSN) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Hudson Technologies

What Is Hudson Technologies's Debt?

As you can see below, Hudson Technologies had US$94.2m of debt at March 2021, down from US$106.6m a year prior. However, it does have US$2.78m in cash offsetting this, leading to net debt of about US$91.4m.

debt-equity-history-analysis
NasdaqCM:HDSN Debt to Equity History June 28th 2021

How Healthy Is Hudson Technologies' Balance Sheet?

We can see from the most recent balance sheet that Hudson Technologies had liabilities of US$48.3m falling due within a year, and liabilities of US$81.3m due beyond that. Offsetting these obligations, it had cash of US$2.78m as well as receivables valued at US$13.9m due within 12 months. So it has liabilities totalling US$112.9m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of US$147.5m, so it does suggest shareholders should keep an eye on Hudson Technologies' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

Weak interest cover of 0.61 times and a disturbingly high net debt to EBITDA ratio of 7.0 hit our confidence in Hudson Technologies like a one-two punch to the gut. The debt burden here is substantial. However, the silver lining was that Hudson Technologies achieved a positive EBIT of US$7.2m in the last twelve months, an improvement on the prior year's loss. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Hudson Technologies can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Happily for any shareholders, Hudson Technologies actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Neither Hudson Technologies's ability to cover its interest expense with its EBIT nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But the good news is it seems to be able to convert EBIT to free cash flow with ease. Taking the abovementioned factors together we do think Hudson Technologies's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - Hudson Technologies has 3 warning signs we think you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. 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.
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