Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that CNH Industrial N.V. (NYSE:CNHI) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does CNH Industrial Carry?
The chart below, which you can click on for greater detail, shows that CNH Industrial had US$23.5b in debt in September 2019; about the same as the year before. On the flip side, it has US$2.96b in cash leading to net debt of about US$20.5b.
A Look At CNH Industrial's Liabilities
According to the last reported balance sheet, CNH Industrial had liabilities of US$5.30b due within 12 months, and liabilities of US$34.1b due beyond 12 months. Offsetting these obligations, it had cash of US$2.96b as well as receivables valued at US$424.0m due within 12 months. So it has liabilities totalling US$36.0b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the US$15.2b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, CNH Industrial would likely require a major re-capitalisation if it had to pay its creditors today.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
CNH Industrial's net debt to EBITDA ratio is 7.9 which suggests rather high debt levels, but its interest cover of 8.0 times suggests the debt is easily serviced. Overall we'd say it seems likely the company is carrying a fairly heavy swag of debt. Unfortunately, CNH Industrial saw its EBIT slide 9.2% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine CNH Industrial's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, CNH Industrial recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for and improvement.
On the face of it, CNH Industrial's net debt to EBITDA left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Taking into account all the aforementioned factors, it looks like CNH Industrial has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. Given our concerns about CNH Industrial's debt levels, it seems only prudent to check if insiders have been ditching the stock.
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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