Stock Analysis

Science Applications International (NYSE:SAIC) Seems To Use Debt Quite Sensibly

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NYSE:SAIC
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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Science Applications International Corporation (NYSE:SAIC) does use debt in its business. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Science Applications International

What Is Science Applications International's Debt?

The image below, which you can click on for greater detail, shows that Science Applications International had debt of US$2.47b at the end of April 2022, a reduction from US$2.59b over a year. On the flip side, it has US$56.0m in cash leading to net debt of about US$2.41b.

debt-equity-history-analysis
NYSE:SAIC Debt to Equity History August 31st 2022

How Strong Is Science Applications International's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Science Applications International had liabilities of US$1.33b due within 12 months and liabilities of US$2.73b due beyond that. Offsetting these obligations, it had cash of US$56.0m as well as receivables valued at US$1.10b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$2.91b.

This deficit isn't so bad because Science Applications International is worth US$5.09b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Science Applications International has a debt to EBITDA ratio of 3.7 and its EBIT covered its interest expense 4.9 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Science Applications International grew its EBIT by 6.5% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to debt. 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 Science Applications International 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, Science Applications International actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

On our analysis Science Applications International's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. For instance it seems like it has to struggle a bit handle its debt, based on its EBITDA,. When we consider all the elements mentioned above, it seems to us that Science Applications International is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Science Applications International (of which 1 shouldn't be ignored!) you should know about.

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.

Valuation is complex, but we're helping make it simple.

Find out whether Science Applications International is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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About NYSE:SAIC

Science Applications International

Science Applications International Corporation provides technical, engineering, and enterprise information technology (IT) services primarily in the United States.

The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.

Analysis AreaScore (0-6)
Valuation3
Future Growth2
Past Performance2
Financial Health4
Dividends2

Read more about these checks in the individual report sections or in our analysis model.

Adequate balance sheet and fair value.