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 can see that Huntsman Corporation (NYSE: HUN) uses debt in its business. But should shareholders be concerned about its use of debt?
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. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first step in examining a business’s debt levels is to consider its cash flow and debt together.
See our latest review for Huntsman
What is Huntsman’s net debt?
The image below, which you can click for more details, shows Huntsman owed $ 1.58 billion in debt at the end of September 2021, down from $ 2.12 billion. over a year. However, he also had $ 505.0 million in cash, so his net debt is $ 1.08 billion.
How healthy is Huntsman’s track record?
According to the latest published balance sheet, Huntsman had liabilities of US $ 1.62 billion due within 12 months and liabilities of US $ 2.99 billion due beyond 12 months. In compensation for these obligations, he had cash of US $ 505.0 million as well as receivables valued at US $ 1.24 billion due within 12 months. It therefore has liabilities totaling US $ 2.87 billion more than its cash and short-term receivables combined.
This deficit is not that big of a deal as Huntsman is worth US $ 6.94 billion, and therefore could possibly raise enough capital to consolidate its balance sheet, should the need arise. But it is clear that it is absolutely necessary to take a close look at whether it can manage its debt without dilution.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its earnings before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt compared to EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
Huntsman’s net debt is only 1.0 times its EBITDA. And its EBIT easily covers its interest costs, being 10.2 times higher. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Best of all, Huntsman increased their EBIT by 456% last year, which is an impressive improvement. If sustained, this growth will make debt even more manageable in the years to come. When analyzing debt levels, the balance sheet is the obvious place to start. But ultimately, the company’s future profitability will decide whether Huntsman 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.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Huntsman has recorded free cash flow of 50% of its EBIT, which is lower than expected. This low cash conversion makes debt management more difficult.
Our point of view
Huntsman’s EBIT growth rate suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. And that’s just the start of the good news since its coverage of interest is also very encouraging. When we consider the range of factors above, it seems Huntsman is being pretty reasonable with his use of debt. This means that they are taking a bit more risk, in the hope of increasing shareholder returns. We would be motivated to seek more stock if we found out that Huntsman insiders have recently bought stocks. If you too are in luck, because today we are sharing our list of reported insider trades for free.
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.
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.
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 any stock 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 any of the stocks mentioned.