Does Hexcel (NYSE:HXL) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Hexcel Corporation (NYSE:HXL) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Hexcel

How Much Debt Does Hexcel Carry?

As you can see below, Hexcel had US$793.3m of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of US$81.5m, its net debt is less, at about US$711.8m.

How Healthy Is Hexcel's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hexcel had liabilities of US$293.7m due within 12 months and liabilities of US$962.7m due beyond that. Offsetting this, it had US$81.5m in cash and US$317.6m in receivables that were due within 12 months. So its liabilities total US$857.3m more than the combination of its cash and short-term receivables.

Since publicly traded Hexcel shares are worth a total of US$5.01b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With a debt to EBITDA ratio of 2.1, Hexcel uses debt artfully but responsibly. And the fact that its trailing twelve months of EBIT was 7.2 times its interest expenses harmonizes with that theme. Hexcel grew its EBIT by 2.0% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Hexcel's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Hexcel produced sturdy free cash flow equating to 57% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Hexcel's conversion of EBIT to free cash flow was a real positive on this analysis, as was its interest cover. On the other hand, its net debt to EBITDA makes us a little less comfortable about its debt. When we consider all the elements mentioned above, it seems to us that Hexcel is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Hexcel has 2 warning signs we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.