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Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ 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. Importantly, Huntington Ingalls Industries, Inc. (NYSE:HII) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Huntington Ingalls Industries’s Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2019 Huntington Ingalls Industries had US$1.50b of debt, an increase on US$1.28b, over one year. However, it also had US$51.0m in cash, and so its net debt is US$1.45b.
How Strong Is Huntington Ingalls Industries’s Balance Sheet?
The latest balance sheet data shows that Huntington Ingalls Industries had liabilities of US$1.96b due within a year, and liabilities of US$3.48b falling due after that. On the other hand, it had cash of US$51.0m and US$1.63b worth of receivables due within a year. So it has liabilities totalling US$3.76b more than its cash and near-term receivables, combined.
This deficit isn’t so bad because Huntington Ingalls Industries is worth US$9.56b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Either way, since Huntington Ingalls Industries does have more debt than cash, it’s worth keeping an eye on its balance sheet.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Huntington Ingalls Industries’s net debt is only 1.24 times its EBITDA. And its EBIT easily covers its interest expense, being 24.0 times the size. So we’re pretty relaxed about its super-conservative use of debt. The good news is that Huntington Ingalls Industries has increased its EBIT by 7.0% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Huntington Ingalls Industries 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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Huntington Ingalls Industries’s free cash flow amounted to 49% of its EBIT, less than we’d expect. That weak cash conversion makes it more difficult to handle indebtedness.
When it comes to the balance sheet, the standout positive for Huntington Ingalls Industries was the fact that it seems able to cover its interest expense with its EBIT confidently. But the other factors we noted above weren’t so encouraging. For instance it seems like it has to struggle a bit to handle its total liabilities. When we consider all the elements mentioned above, it seems to us that Huntington Ingalls Industries is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. Of course, we wouldn’t say no to the extra confidence that we’d gain if we knew that Huntington Ingalls Industries insiders have been buying shares: if you’re on the same wavelength, you can find out if insiders are buying by clicking this link.
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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If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.