Howard Marks put it well when he said that, rather than worrying about stock price volatility, “The possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried. ” 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 Hexagon AB (publ) (STO: HEXA B) has debt on its balance sheet. But should shareholders be concerned about its use of debt?
Why Does Debt Bring Risk?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, especially capital intensive businesses. When we think of a business’s use of debt, we first look at cash flow and debt together.
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What is Hexagon’s net debt?
You can click on the graph below for historical figures, but it shows that as of June 2021, Hexagon had € 2.27 billion in debt, an increase from € 2.14 billion, on a year. However, he also had € 412.7 million in cash, so his net debt is € 1.86 billion.
Is Hexagon’s track record healthy?
The latest balance sheet data shows that Hexagon had debts of 2.16 billion euros due within one year, and debts of 2.51 billion euros maturing thereafter. On the other hand, it had cash of € 412.7 million and € 1.04 billion in receivables within one year. It therefore has liabilities totaling 3.22 billion euros more than its combined cash and short-term receivables.
Considering that the listed Hexagon shares are worth a very impressive total of 37.8 billion euros, it seems unlikely that this level of liabilities is a major threat. But there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward.
We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Hexagon’s net debt is only 1.3 times its EBITDA. And its EBIT easily covers its interest costs, being 64.4 times higher. So we’re pretty relaxed about its ultra-conservative use of debt. On top of that, Hexagon has increased its EBIT by 47% over the past twelve months, and this growth will make it easier to process its debt. The balance sheet is clearly the area you need to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Hexagon can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Hexagon has recorded free cash flow of 77% of its EBIT, which is close to normal given that free cash flow excludes interest and taxes. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
Hexagon’s interest coverage suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. And that’s just the start of good news as its EBIT growth rate is also very encouraging. Considering this range of factors, it seems to us that Hexagon is fairly cautious with its debt, and the risks appear to be well under control. The balance sheet therefore seems rather healthy to us. On top of most other metrics, we think it’s important to track how quickly earnings per share are growing, if at all. If you also understood this, you are in luck because today you can check out this interactive graph of historical earnings per share of Hexagon for free.
If you are interested in investing in companies that can generate profits without the burden of debt, check out this page free list of growing companies that have net cash on the balance sheet.
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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.
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