Is Booz Allen Hamilton Holding (NYSE:BAH) A Risky Investment?

By
Simply Wall St
Published
January 03, 2021
NYSE:BAH

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Booz Allen Hamilton Holding Corporation (NYSE:BAH) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Booz Allen Hamilton Holding

How Much Debt Does Booz Allen Hamilton Holding Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Booz Allen Hamilton Holding had debt of US$2.45b, up from US$2.15b in one year. However, it also had US$1.28b in cash, and so its net debt is US$1.17b.

debt-equity-history-analysis
NYSE:BAH Debt to Equity History January 3rd 2021

A Look At Booz Allen Hamilton Holding's Liabilities

According to the last reported balance sheet, Booz Allen Hamilton Holding had liabilities of US$1.40b due within 12 months, and liabilities of US$2.91b due beyond 12 months. On the other hand, it had cash of US$1.28b and US$1.47b worth of receivables due within a year. So its liabilities total US$1.57b more than the combination of its cash and short-term receivables.

Given Booz Allen Hamilton Holding has a humongous market capitalization of US$12.0b, 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.

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.

With net debt sitting at just 1.5 times EBITDA, Booz Allen Hamilton Holding is arguably pretty conservatively geared. And it boasts interest cover of 8.3 times, which is more than adequate. And we also note warmly that Booz Allen Hamilton Holding grew its EBIT by 11% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Booz Allen Hamilton Holding'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 we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Booz Allen Hamilton Holding recorded free cash flow worth 79% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, Booz Allen Hamilton Holding's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And we also thought its interest cover was a positive. Looking at the bigger picture, we think Booz Allen Hamilton Holding's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. Case in point: We've spotted 2 warning signs for Booz Allen Hamilton Holding you should be aware of.

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.

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This article by Simply Wall St is general in nature. 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.
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