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’. 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. As with many other companies ITT Inc. (NYSE:ITT) makes use of debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is ITT’s Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2019 ITT had US$135.3m of debt, an increase on US$156, over one year. But it also has US$555.7m in cash to offset that, meaning it has US$420.4m net cash.
How Healthy Is ITT’s Balance Sheet?
We can see from the most recent balance sheet that ITT had liabilities of US$888.8m falling due within a year, and liabilities of US$1.18b due beyond that. On the other hand, it had cash of US$555.7m and US$607.9m worth of receivables due within a year. So it has liabilities totalling US$900.7m more than its cash and near-term receivables, combined.
Of course, ITT has a market capitalization of US$6.50b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, ITT boasts net cash, so it’s fair to say it does not have a heavy debt load!
Fortunately, ITT grew its EBIT by 10.0% in the last year, making that debt load look even more manageable. 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, we’ve discovered 1 warning sign for ITT which any shareholder or potential investor should be aware of.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While ITT has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, ITT recorded free cash flow worth 61% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Although ITT’s balance sheet isn’t particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$420.4m. So we don’t think ITT’s use of debt is risky. Of course, we wouldn’t say no to the extra confidence that we’d gain if we knew that ITT 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 you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.