Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk. It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies ITT Inc. (NYSE:ITT) makes use of debt. But the more important question is: how much risk is that debt creating?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is ITT's Net Debt?
You can click the graphic below for the historical numbers, but it shows that ITT had US$163.7m of debt in June 2019, down from US$217.9m, one year before. However, it does have US$531.9m in cash offsetting this, leading to net cash of US$368.2m.
How Strong Is ITT's Balance Sheet?
The latest balance sheet data shows that ITT had liabilities of US$892.4m due within a year, and liabilities of US$1.21b falling due after that. On the other hand, it had cash of US$531.9m and US$628.3m worth of receivables due within a year. So it has liabilities totalling US$943.8m more than its cash and near-term receivables, combined.
Of course, ITT has a market capitalization of US$5.33b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, ITT boasts net cash, so it's fair to say it does not have a heavy debt load!
Also good is that ITT grew its EBIT at 15% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if ITT 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. ITT may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, ITT produced sturdy free cash flow equating to 58% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Although ITT's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$368.2m. And we liked the look of last year's 15% year-on-year EBIT growth. So is ITT's debt a risk? It doesn't seem so to us. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that ITT insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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