Does Hess (NYSE:HES) Have A Healthy Balance Sheet?

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. As with many other companies Hess Corporation (NYSE:HES) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Hess

What Is Hess's Net Debt?

The chart below, which you can click on for greater detail, shows that Hess had US$8.46b in debt in December 2021; about the same as the year before. However, because it has a cash reserve of US$2.71b, its net debt is less, at about US$5.75b.

A Look At Hess' Liabilities

Zooming in on the latest balance sheet data, we can see that Hess had liabilities of US$3.06b due within 12 months and liabilities of US$10.4b due beyond that. Offsetting these obligations, it had cash of US$2.71b as well as receivables valued at US$1.21b due within 12 months. So its liabilities total US$9.57b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Hess is worth a massive US$32.7b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). 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).

Hess's net debt is sitting at a very reasonable 1.6 times its EBITDA, while its EBIT covered its interest expense just 4.3 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Notably, Hess made a loss at the EBIT level, last year, but improved that to positive EBIT of US$2.1b in the last twelve months. 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 Hess's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the most recent year, Hess recorded free cash flow worth 55% 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.

Our View

Both Hess's ability to to convert EBIT to free cash flow and its net debt to EBITDA gave us comfort that it can handle its debt. On the other hand, its interest cover makes us a little less comfortable about its debt. When we consider all the factors mentioned above, we do feel a bit cautious about Hess's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. For instance, we've identified 3 warning signs for Hess that you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.