Howmet Aerospace (NYSE:HWM) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 can see that Howmet Aerospace Inc. (NYSE:HWM) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Howmet Aerospace

What Is Howmet Aerospace's Net Debt?

The image below, which you can click on for greater detail, shows that Howmet Aerospace had debt of US$3.66b at the end of June 2024, a reduction from US$3.99b over a year. However, because it has a cash reserve of US$752.0m, its net debt is less, at about US$2.91b.

A Look At Howmet Aerospace's Liabilities

The latest balance sheet data shows that Howmet Aerospace had liabilities of US$2.36b due within a year, and liabilities of US$4.04b falling due after that. Offsetting this, it had US$752.0m in cash and US$768.0m in receivables that were due within 12 months. So it has liabilities totalling US$4.88b more than its cash and near-term receivables, combined.

Since publicly traded Howmet Aerospace shares are worth a very impressive total of US$39.8b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With a debt to EBITDA ratio of 1.7, Howmet Aerospace uses debt artfully but responsibly. And the fact that its trailing twelve months of EBIT was 7.7 times its interest expenses harmonizes with that theme. Also relevant is that Howmet Aerospace has grown its EBIT by a very respectable 30% in the last year, thus enhancing its ability to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Howmet Aerospace 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 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. During the last three years, Howmet Aerospace produced sturdy free cash flow equating to 57% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, Howmet Aerospace's impressive EBIT growth rate implies it has the upper hand on its debt. And its interest cover is good too. Taking all this data into account, it seems to us that Howmet Aerospace takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. Be aware that Howmet Aerospace is showing 2 warning signs in our investment analysis , you should know about...

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.