Legendary fund manager Li Lu (whom Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. When we think about the risk level of a business, we always like to look at its use of debt, because debt overload can lead to bankruptcy. We can see that HEICO Corporation (NYSE: HEI) uses debt in its business. But the most important question is: what is the risk that this debt creates?
Why is debt risky?
Debt and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. 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 shareholders because lenders are forcing them to raise capital at a difficult price. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
Check out our latest review for HEICO
What is HEICO’s net debt?
You can click on the graph below for the historical numbers, but it shows that as of January 2021, HEICO had $ 601.8 million in debt, an increase of $ 567.9 million over one year. However, he also had US $ 399.4 million in cash, and therefore his net debt is US $ 202.4 million.
A look at the responsibilities of HEICO
We can see from the most recent balance sheet that HEICO had liabilities of US $ 234.7 million due within one year and liabilities of US $ 1.03 billion due beyond. In contrast, it had US $ 399.4 million in cash and US $ 260.2 million in receivables due within one year. As a result, its liabilities total $ 603.6 million more than the combination of its cash and short-term receivables.
Of course, HEICO has a titanic market cap of US $ 17.3 billion, so those liabilities are likely manageable. However, we think it’s worth keeping an eye on the strength of its balance sheet as it can change over time. But anyway, HEICO has virtually no net debt, so it’s fair to say that it doesn’t have heavy debt!
In order to size a company’s debt against its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest expense. (its interest coverage). The advantage of this approach is that we take into account both the absolute quantum of the debt (with net debt over EBITDA) and the actual interest charges associated with that debt (with its interest coverage ratio).
HEICO has a low net debt to EBITDA ratio of just 0.46. And its EBIT covers its interest costs 30.6 times more. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. It is just as good that HEICO’s load is not too heavy, as its EBIT is down 26% compared to last year. When a business sees its profit pool, it can sometimes see its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when analyzing debt. 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 are thinking, you might find this free analyst earnings forecast report interesting.
But our last consideration is also important, because a business cannot pay its debt with profits on paper; he needs cash. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, HEICO has recorded free cash flow of 93% of its EBIT, which is stronger than we usually expected. This puts him in a very strong position to pay off his debt.
Our point of view
The good news is that HEICO’s demonstrated ability to cover its interest costs with its EBIT delights us like a fluffy puppy does to a toddler. But the truth is that we are concerned about its growth rate of EBIT. All this considered, it looks like HEICO can comfortably manage its current debt levels. Of course, while this leverage can improve returns on equity, it comes with more risk, so it’s worth keeping an eye out for. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. For example, we have identified 1 warning sign for HEICO that you need to be aware of.
If, after all of this, you’re more interested in a fast-growing company with a rock-solid balance sheet, then check out our list of cash flow growth stocks right now.
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