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.' 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 Babcock & Wilcox Enterprises, Inc. (NYSE:BW) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is Babcock & Wilcox Enterprises's Net Debt?
As you can see below, Babcock & Wilcox Enterprises had US$340.3m of debt, at December 2021, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has US$224.9m in cash leading to net debt of about US$115.4m.
How Healthy Is Babcock & Wilcox Enterprises' Balance Sheet?
We can see from the most recent balance sheet that Babcock & Wilcox Enterprises had liabilities of US$253.4m falling due within a year, and liabilities of US$601.3m due beyond that. Offsetting this, it had US$224.9m in cash and US$246.8m in receivables that were due within 12 months. So it has liabilities totalling US$383.0m more than its cash and near-term receivables, combined.
Babcock & Wilcox Enterprises has a market capitalization of US$671.7m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Given net debt is only 1.3 times EBITDA, it is initially surprising to see that Babcock & Wilcox Enterprises's EBIT has low interest coverage of 1.9 times. So one way or the other, it's clear the debt levels are not trivial. We also note that Babcock & Wilcox Enterprises improved its EBIT from a last year's loss to a positive US$74m. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Babcock & Wilcox Enterprises'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.
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. During the last year, Babcock & Wilcox Enterprises burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
To be frank both Babcock & Wilcox Enterprises's interest cover and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. Overall, we think it's fair to say that Babcock & Wilcox Enterprises has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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 Babcock & Wilcox Enterprises is showing 1 warning sign in our investment analysis , you should know about...
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.
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.