Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘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. Importantly, Huntington Ingalls Industries, Inc. (NYSE:HII) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company’s use of debt, we first look at cash and debt together.
How Much Debt Does Huntington Ingalls Industries Carry?
You can click the graphic below for the historical numbers, but it shows that Huntington Ingalls Industries had US$1.65b of debt in March 2021, down from US$1.76b, one year before. On the flip side, it has US$407.0m in cash leading to net debt of about US$1.24b.
A Look At Huntington Ingalls Industries’ Liabilities
According to the last reported balance sheet, Huntington Ingalls Industries had liabilities of US$2.29b due within 12 months, and liabilities of US$3.95b due beyond 12 months. On the other hand, it had cash of US$407.0m and US$1.83b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$4.00b.
Huntington Ingalls Industries has a market capitalization of US$8.22b, so it could very likely raise cash to ameliorate 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
With net debt sitting at just 1.1 times EBITDA, Huntington Ingalls Industries is arguably pretty conservatively geared. And it boasts interest cover of 9.8 times, which is more than adequate. Huntington Ingalls Industries’s EBIT was pretty flat over the last year, but that shouldn’t be an issue given the it doesn’t have a lot of 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 Huntington Ingalls Industries 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Huntington Ingalls Industries recorded free cash flow worth 57% 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.
On our analysis Huntington Ingalls Industries’s interest cover 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 to handle its total liabilities. Considering this range of data points, we think Huntington Ingalls Industries is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. We’ve identified 3 warning signs with Huntington Ingalls Industries , and understanding them should be part of your investment process.
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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