Here's Why Heritage-Crystal Clean (NASDAQ:HCCI) Can Manage Its Debt Responsibly

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. We can see that Heritage-Crystal Clean, Inc (NASDAQ:HCCI) 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Heritage-Crystal Clean

How Much Debt Does Heritage-Crystal Clean Carry?

As you can see below, Heritage-Crystal Clean had US$29.6m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$52.7m in cash offsetting this, leading to net cash of US$23.1m.

A Look At Heritage-Crystal Clean's Liabilities

We can see from the most recent balance sheet that Heritage-Crystal Clean had liabilities of US$72.0m falling due within a year, and liabilities of US$110.8m due beyond that. On the other hand, it had cash of US$52.7m and US$48.9m worth of receivables due within a year. So its liabilities total US$81.2m more than the combination of its cash and short-term receivables.

Given Heritage-Crystal Clean has a market capitalization of US$488.4m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Heritage-Crystal Clean also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that Heritage-Crystal Clean's load is not too heavy, because its EBIT was down 36% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Heritage-Crystal Clean 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. While Heritage-Crystal Clean 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, Heritage-Crystal Clean recorded free cash flow worth 71% 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.

Summing up

While Heritage-Crystal Clean does have more liabilities than liquid assets, it also has net cash of US$23.1m. The cherry on top was that in converted 71% of that EBIT to free cash flow, bringing in US$8.9m. So we are not troubled with Heritage-Crystal Clean's debt use. 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. For example, we've discovered 3 warning signs for Heritage-Crystal Clean that you should be aware of before investing here.

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.

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