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.' 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. We note that BWX Technologies, Inc. (NYSE:BWXT) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.
How Much Debt Does BWX Technologies Carry?
You can click the graphic below for the historical numbers, but it shows that as of December 2020 BWX Technologies had US$951.4m of debt, an increase on US$824.2m, over one year. However, it also had US$46.3m in cash, and so its net debt is US$905.1m.
How Strong Is BWX Technologies' Balance Sheet?
The latest balance sheet data shows that BWX Technologies had liabilities of US$529.7m due within a year, and liabilities of US$1.15b falling due after that. Offsetting this, it had US$46.3m in cash and US$680.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$949.5m.
Of course, BWX Technologies has a market capitalization of US$6.44b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
BWX Technologies's net debt to EBITDA ratio of about 2.2 suggests only moderate use of debt. And its strong interest cover of 11.9 times, makes us even more comfortable. If BWX Technologies can keep growing EBIT at last year's rate of 14% over the last year, then it will find its debt load easier to manage. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine BWX Technologies'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 we always check how much of that EBIT is translated into free cash flow. In the last three years, BWX Technologies created free cash flow amounting to 10% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.
When it comes to the balance sheet, the standout positive for BWX Technologies was the fact that it seems able to cover its interest expense with its EBIT confidently. However, our other observations weren't so heartening. For instance it seems like it has to struggle a bit to convert EBIT to free cash flow. When we consider all the elements mentioned above, it seems to us that BWX Technologies is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for BWX Technologies you should be aware of, and 1 of them is a bit unpleasant.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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