- Oops!Something went wrong.Please try again later.
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. When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Heritage-Crystal Clean, Inc (NASDAQ:HCCI) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
What Is Heritage-Crystal Clean's Debt?
As you can see below, Heritage-Crystal Clean had US$29.3m of debt, at December 2019, which is about the same as the year before. You can click the chart for greater detail. But it also has US$60.7m in cash to offset that, meaning it has US$31.3m net cash.
A Look At Heritage-Crystal Clean's Liabilities
According to the last reported balance sheet, Heritage-Crystal Clean had liabilities of US$90.4m due within 12 months, and liabilities of US$115.2m due beyond 12 months. Offsetting these obligations, it had cash of US$60.7m as well as receivables valued at US$55.6m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$89.4m.
This deficit isn't so bad because Heritage-Crystal Clean is worth US$401.1m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Heritage-Crystal Clean boasts net cash, so it's fair to say it does not have a heavy debt load!
And we also note warmly that Heritage-Crystal Clean grew its EBIT by 18% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Heritage-Crystal Clean can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Heritage-Crystal Clean 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, Heritage-Crystal Clean generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
Although Heritage-Crystal Clean'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$31.3m. And it impressed us with free cash flow of US$22m, being 83% of its EBIT. So we don't think Heritage-Crystal Clean's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 3 warning signs we've spotted with Heritage-Crystal Clean .
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.