We Think Illinois Tool Works (NYSE:ITW) Can Manage Its Debt With Ease

By
Simply Wall St
Published
February 17, 2022
NYSE:ITW
Source: Shutterstock

Warren Buffett famously said, '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. We can see that Illinois Tool Works Inc. (NYSE:ITW) does use debt in its business. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Illinois Tool Works

What Is Illinois Tool Works's Net Debt?

The image below, which you can click on for greater detail, shows that Illinois Tool Works had debt of US$7.69b at the end of December 2021, a reduction from US$8.12b over a year. On the flip side, it has US$1.53b in cash leading to net debt of about US$6.16b.

debt-equity-history-analysis
NYSE:ITW Debt to Equity History February 17th 2022

How Strong Is Illinois Tool Works' Balance Sheet?

We can see from the most recent balance sheet that Illinois Tool Works had liabilities of US$3.47b falling due within a year, and liabilities of US$8.98b due beyond that. On the other hand, it had cash of US$1.53b and US$2.94b worth of receivables due within a year. So it has liabilities totalling US$7.98b more than its cash and near-term receivables, combined.

Since publicly traded Illinois Tool Works shares are worth a very impressive total of US$68.9b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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.

We'd say that Illinois Tool Works's moderate net debt to EBITDA ratio ( being 1.6), indicates prudence when it comes to debt. And its strong interest cover of 18.4 times, makes us even more comfortable. Another good sign is that Illinois Tool Works has been able to increase its EBIT by 21% in twelve months, making it easier 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 Illinois Tool Works 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.

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 most recent three years, Illinois Tool Works recorded free cash flow worth 76% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Illinois Tool Works's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Looking at the bigger picture, we think Illinois Tool Works's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. 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. To that end, you should be aware of the 1 warning sign we've spotted with Illinois Tool Works .

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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