Warren Buffett famously said, '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. We note that Hyster-Yale Materials Handling, Inc. (NYSE:HY) does have debt on its balance sheet. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Hyster-Yale Materials Handling's Debt?
As you can see below, at the end of June 2019, Hyster-Yale Materials Handling had US$357.0m of debt, up from US$273.1m a year ago. Click the image for more detail. However, it does have US$50.3m in cash offsetting this, leading to net debt of about US$306.7m.
How Strong Is Hyster-Yale Materials Handling's Balance Sheet?
According to the last reported balance sheet, Hyster-Yale Materials Handling had liabilities of US$888.3m due within 12 months, and liabilities of US$462.4m due beyond 12 months. Offsetting this, it had US$50.3m in cash and US$530.8m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$769.6m.
This is a mountain of leverage relative to its market capitalization of US$812.1m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
While Hyster-Yale Materials Handling's debt to EBITDA ratio (3.8) suggests that it uses some debt, its interest cover is very weak, at 2.0, suggesting high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Even worse, Hyster-Yale Materials Handling saw its EBIT tank 51% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Hyster-Yale Materials Handling'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Hyster-Yale Materials Handling reported free cash flow worth 7.5% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.
To be frank both Hyster-Yale Materials Handling's interest cover and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. And furthermore, its level of total liabilities also fails to instill confidence. After considering the datapoints discussed, we think Hyster-Yale Materials Handling has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. Given our concerns about Hyster-Yale Materials Handling's debt levels, it seems only prudent to check if insiders have been ditching the stock.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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