Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from risk.” When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Like many other companies HEICO Company (NYSE: HEI) uses debt. But the real question is whether this debt makes the business risky.
When is debt a problem?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. Of course, debt can be an important tool in businesses, especially capital intensive businesses. When we think of a business’s use of debt, we first look at cash flow and debt together.
What is HEICO’s net debt?
You can click on the chart below for historical numbers, but it shows that HEICO had $ 375.0 million in debt as of July 2021, up from $ 739.0 million a year earlier. However, because it has a cash reserve of US $ 269.8 million, its net debt is less, at around US $ 105.2 million.
NYSE: HEI Debt to Equity History September 19, 2021
How healthy is HEICO’s balance sheet?
The latest balance sheet data shows that HEICO had liabilities of US $ 262.2 million due within one year and liabilities of US $ 754.6 million due thereafter. In compensation for these obligations, it had cash of US $ 269.8 million as well as receivables valued at US $ 271.4 million due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 475.6 million.
Given that listed HEICO shares are worth a very impressive US $ 16.1 billion total, it seems unlikely that this level of liabilities is a major threat. However, we think it’s worth keeping an eye on the strength of its balance sheet as it can change over time. But in any case, HEICO has virtually no net debt, so it’s fair to say that it doesn’t have a lot of debt!
We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). Thus, we consider debt versus earnings with and without amortization charges.
HEICO’s net debt is only 0.23 times its EBITDA. And its EBIT covers its interest costs 42.1 times more. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. But the other side of the story is that HEICO has seen its EBIT drop 9.5% in the past year. If profits continue to decline at this rate, the company may find it increasingly difficult to manage debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future profits, more than anything, that will determine HEICO’s ability to maintain a healthy balance sheet in the future. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business can only pay off its debts with hard cash, not with book profits. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, HEICO has recorded free cash flow totaling 99% of its EBIT, which is higher than what we usually expected. This puts him in a very strong position to pay off the debt.
Our point of view
HEICO’s interest coverage suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. But frankly, we think its EBIT growth rate undermines that impression a bit. Looking at the big picture, we think HEICO’s use of debt looks very reasonable and we don’t care. While debt comes with risk, when used wisely, it can also generate a higher return on equity. We would be motivated to seek more stock if we found out that HEICO insiders have recently bought stocks. If you too are in luck, because today we are sharing our list of reported insider trades for free.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.
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