Hillenbrand (NYSE:HI) seems to be using debt quite wisely

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Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We note that Hillenbrand, Inc. (NYSE:HI) has debt on its balance sheet. But does this debt worry shareholders?

What risk does debt carry?

Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, many companies use debt to finance their growth, without any negative consequences. When we look at debt levels, we first consider cash and debt levels, together.

See our latest analysis for Hillenbrand

What is Hillenbrand’s debt?

As you can see below, Hillenbrand had $1.21 billion in debt as of March 2022, roughly the same as the year before. You can click on the graph for more details. On the other hand, he has $444.8 million in cash, resulting in a net debt of around $769.2 million.

NYSE: HI Historical Debt to Equity July 17, 2022

How healthy is Hillenbrand’s balance sheet?

We can see from the most recent balance sheet that Hillenbrand had liabilities of $1.07 billion due in one year, and liabilities of $1.71 billion beyond that. In compensation for these obligations, it had cash of US$444.8 million as well as receivables valued at US$479.5 million and maturing within 12 months. Thus, its liabilities total $1.86 billion more than the combination of its cash and short-term receivables.

This shortfall is sizable relative to its market capitalization of US$2.79 billion, so he suggests shareholders watch Hillenbrand’s use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly.

We measure a company’s leverage against its earning power 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 charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

While Hillenbrand’s low debt-to-EBITDA ratio of 1.4 suggests only modest debt usage, the fact that EBIT only covered interest expense by 6.2 times last year makes us reflect. We therefore recommend that you closely monitor the impact of financing costs on the business. Although Hillenbrand doesn’t appear to have gained much on the EBIT line, at least earnings are holding steady for now. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Hillenbrand can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Hillenbrand has recorded free cash flow of 90% of its EBIT, which is higher than what we would normally expect. This positions him well to pay off debt if desired.

Our point of view

According to our analysis, Hillenbrand’s conversion of EBIT to free cash flow should signal that it will not have too many problems with its debt. However, our other observations were not so encouraging. For example, it looks like he has to struggle a bit to manage his total liabilities. Given this range of data points, we believe Hillenbrand is in a good position to manage its level of leverage. But be warned: we believe debt levels are high enough to warrant continued monitoring. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 1 warning sign for Hillenbrand you should know.

Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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