Howmet Aerospace (NYSE:HWM) Has A Somewhat Strained Balance Sheet

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.' 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. Importantly, Howmet Aerospace Inc. (NYSE:HWM) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Howmet Aerospace

How Much Debt Does Howmet Aerospace Carry?

The chart below, which you can click on for greater detail, shows that Howmet Aerospace had US$4.17b in debt in September 2022; about the same as the year before. However, it also had US$453.0m in cash, and so its net debt is US$3.72b.

How Strong Is Howmet Aerospace's Balance Sheet?

According to the last reported balance sheet, Howmet Aerospace had liabilities of US$1.38b due within 12 months, and liabilities of US$5.28b due beyond 12 months. Offsetting these obligations, it had cash of US$453.0m as well as receivables valued at US$600.0m due within 12 months. So its liabilities total US$5.60b more than the combination of its cash and short-term receivables.

Howmet Aerospace has a very large market capitalization of US$15.8b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

Howmet Aerospace's debt is 3.0 times its EBITDA, and its EBIT cover its interest expense 4.3 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. The good news is that Howmet Aerospace improved its EBIT by 9.4% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Howmet Aerospace 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 it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Howmet Aerospace reported free cash flow worth 17% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Both Howmet Aerospace's conversion of EBIT to free cash flow and its net debt to EBITDA were discouraging. But its not so bad at growing its EBIT. Looking at all the angles mentioned above, it does seem to us that Howmet Aerospace is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Howmet Aerospace (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

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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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.