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. 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. As with many other companies The Hackett Group, Inc. (NASDAQ:HCKT) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Hackett Group Carry?
As you can see below, Hackett Group had US$4.50m of debt at June 2019, down from US$13.5m a year prior. But it also has US$16.7m in cash to offset that, meaning it has US$12.2m net cash.
A Look At Hackett Group's Liabilities
We can see from the most recent balance sheet that Hackett Group had liabilities of US$42.3m falling due within a year, and liabilities of US$17.9m due beyond that. On the other hand, it had cash of US$16.7m and US$54.5m worth of receivables due within a year. So it actually has US$11.1m more liquid assets than total liabilities.
This surplus suggests that Hackett Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Hackett Group has more cash than debt is arguably a good indication that it can manage its debt safely.
Fortunately, Hackett Group grew its EBIT by 4.1% in the last year, making that debt load look even more manageable. 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 Hackett Group 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Hackett Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Hackett Group produced sturdy free cash flow equating to 75% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
While it is always sensible to investigate a company's debt, in this case Hackett Group has US$12.2m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 75% of that EBIT to free cash flow, bringing in US$28m. So is Hackett Group's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Hackett Group's earnings per share history for free.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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