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.' 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, Lockheed Martin Corporation (NYSE:LMT) does carry debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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 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 step when considering a company's debt levels is to consider its cash and debt together.
What Is Lockheed Martin's Net Debt?
As you can see below, Lockheed Martin had US$11.0b of debt at March 2021, down from US$12.7b a year prior. On the flip side, it has US$2.93b in cash leading to net debt of about US$8.12b.
How Strong Is Lockheed Martin's Balance Sheet?
We can see from the most recent balance sheet that Lockheed Martin had liabilities of US$14.7b falling due within a year, and liabilities of US$30.4b due beyond that. Offsetting these obligations, it had cash of US$2.93b as well as receivables valued at US$13.1b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$29.0b.
While this might seem like a lot, it is not so bad since Lockheed Martin has a huge market capitalization of US$106.5b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
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.
Lockheed Martin's net debt is only 0.79 times its EBITDA. And its EBIT covers its interest expense a whopping 15.5 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also good is that Lockheed Martin grew its EBIT at 16% over the last year, further increasing its ability to manage 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 Lockheed Martin 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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Lockheed Martin recorded free cash flow worth 63% 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.
Happily, Lockheed Martin's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its net debt to EBITDA also supports that impression! When we consider the range of factors above, it looks like Lockheed Martin is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Lockheed Martin is showing 2 warning signs in our investment analysis , you should know about...
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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