Here's Why Herc Holdings (NYSE:HRI) Is Weighed Down By Its Debt Load

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. We can see that Herc Holdings Inc. (NYSE:HRI) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Herc Holdings

What Is Herc Holdings's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Herc Holdings had debt of US$3.80b, up from US$3.27b in one year. And it doesn't have much cash, so its net debt is about the same.

How Healthy Is Herc Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Herc Holdings had liabilities of US$474.0m due within 12 months and liabilities of US$5.43b due beyond that. Offsetting this, it had US$63.0m in cash and US$560.0m in receivables that were due within 12 months. So its liabilities total US$5.28b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of US$3.87b, we think shareholders really should watch Herc Holdings's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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.

Herc Holdings has a debt to EBITDA ratio of 4.7 and its EBIT covered its interest expense 2.9 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. However, one redeeming factor is that Herc Holdings grew its EBIT at 14% over the last 12 months, boosting its ability to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Herc Holdings'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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Herc Holdings recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

On the face of it, Herc Holdings's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Overall, it seems to us that Herc Holdings's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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 Herc Holdings is showing 3 warning signs in our investment analysis , and 1 of those 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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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com