CNH Industrial (NYSE:CNHI) Seems To Use Debt Quite Sensibly

By
Simply Wall St
Published
September 30, 2021
NYSE:CNHI
Source: Shutterstock

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that CNH Industrial N.V. (NYSE:CNHI) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 CNH Industrial

How Much Debt Does CNH Industrial Carry?

The chart below, which you can click on for greater detail, shows that CNH Industrial had US$24.5b in debt in June 2021; about the same as the year before. However, because it has a cash reserve of US$7.84b, its net debt is less, at about US$16.7b.

debt-equity-history-analysis
NYSE:CNHI Debt to Equity History October 1st 2021

How Strong Is CNH Industrial's Balance Sheet?

We can see from the most recent balance sheet that CNH Industrial had liabilities of US$11.3b falling due within a year, and liabilities of US$31.9b due beyond that. On the other hand, it had cash of US$7.84b and US$522.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$34.8b.

This deficit casts a shadow over the US$22.5b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, CNH Industrial would likely require a major re-capitalisation if it had to pay its creditors today.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

As it happens CNH Industrial has a fairly concerning net debt to EBITDA ratio of 5.1 but very strong interest coverage of 13.8. So either it has access to very cheap long term debt or that interest expense is going to grow! Pleasingly, CNH Industrial is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 875% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if CNH Industrial 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, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, CNH Industrial actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

CNH Industrial's interest cover was a real positive on this analysis, as was its conversion of EBIT to free cash flow. In contrast, our confidence was undermined by its apparent struggle to handle its total liabilities. Looking at all this data makes us feel a little cautious about CNH Industrial's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. We've identified 3 warning signs with CNH Industrial , 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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