Is Delek US Holdings (NYSE:DK) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 note that Delek US Holdings, Inc. (NYSE:DK) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Our analysis indicates that DK is potentially undervalued!

How Much Debt Does Delek US Holdings Carry?

As you can see below, at the end of September 2022, Delek US Holdings had US$3.04b of debt, up from US$2.56b a year ago. Click the image for more detail. However, it also had US$1.15b in cash, and so its net debt is US$1.89b.

How Healthy Is Delek US Holdings' Balance Sheet?

According to the last reported balance sheet, Delek US Holdings had liabilities of US$3.83b due within 12 months, and liabilities of US$3.28b due beyond 12 months. On the other hand, it had cash of US$1.15b and US$1.05b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$4.91b.

This deficit casts a shadow over the US$1.90b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Delek US Holdings would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Delek US Holdings has net debt worth 2.4 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 3.0 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. However, the silver lining was that Delek US Holdings achieved a positive EBIT of US$504m in the last twelve months, an improvement on the prior year's loss. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Delek US Holdings's ability to maintain a healthy balance sheet going forward. 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. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Delek US Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Mulling over Delek US Holdings's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Once we consider all the factors above, together, it seems to us that Delek US Holdings's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. We've identified 3 warning signs with Delek US Holdings (at least 2 which are a bit unpleasant) , and understanding them should be part of your investment process.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.