Warren Buffett said: “Volatility is far from synonymous with risk”. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. We note that Howmet Aerospace Inc. (NYSE: HWM) has debt on its balance sheet. But does this debt concern shareholders?
What risk does debt entail?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, many companies use debt to finance their growth without negative consequences. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
Check out our latest analysis for Howmet Aerospace
What is the debt of Howmet Aerospace?
You can click on the graph below for historical figures, but it shows Howmet Aerospace had a debt of US $ 4.29 billion in September 2021, up from US $ 5.08 billion a year earlier. However, because it has a cash reserve of US $ 724.0 million, its net debt is less, at around US $ 3.56 billion.
How strong is Howmet Aerospace’s balance sheet?
According to the latest published balance sheet, Howmet Aerospace had a liability of US $ 1.21 billion due within 12 months and a liability of US $ 5.57 billion due beyond 12 months. In return, he had $ 724.0 million in cash and $ 465.0 million in receivables due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 5.59 billion.
While that might sound like a lot, it’s not that bad since Howmet Aerospace has a massive market cap of US $ 14.3 billion, and so it could likely strengthen its balance sheet by raising capital if needed. But we absolutely want to keep our eyes open for indications that its debt is too risky.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). Thus, we consider debt versus earnings with and without amortization charges.
While we’re not worried about Howmet Aerospace’s net debt to EBITDA ratio of 2.9, we do think its ultra-low 2.5 times interest coverage is a sign of high leverage. It seems clear that the cost of borrowing money is having a negative impact on shareholder returns lately. Notably, Howmet Aerospace’s EBIT has been fairly stable over the past year, which is not ideal given the leverage. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Howmet Aerospace can strengthen its balance sheet over time. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Considering the past three years, Howmet Aerospace has actually experienced an overall cash outflow. Debt is typically more expensive and almost always riskier in the hands of a business with negative free cash flow. Shareholders should hope for improvement.
Our point of view
At first glance, Howmet Aerospace’s interest hedging left us hesitant about the stock, and its conversion of EBIT to free cash flow was no more appealing than the single empty restaurant on the busiest night of the year. year. That said, his ability to increase his EBIT is not that much of a concern. Once we consider all of the above factors together it seems Howmet Aerospace’s debt makes it a bit risky. Some people like this kind of risk, but we are aware of the potential pitfalls, so we would probably prefer him to carry less debt. The balance sheet is clearly the area you need to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. Be aware that Howmet Aerospace shows 2 warning signs in our investment analysis , and 1 of them is a bit rude …
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
Do you have any feedback on this item? Are you worried about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.