Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Above all, H&E Equipment Services, Inc. (NASDAQ:HEES) is in debt. But the more important question is: what risk does this debt create?
When is debt dangerous?
Debt and other liabilities become risky for a business when it cannot easily meet those 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. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. The first step when considering a company’s debt levels is to consider its cash and debt together.
Check out our latest analysis for H&E Equipment Services
How much debt does H&E Equipment Services have?
As you can see below, H&E Equipment Services had $1.26 billion in debt as of December 2021, about the same as the year before. You can click on the graph for more details. However, he has $357.3 million in cash to offset this, resulting in a net debt of approximately $903.6 million.
A look at the responsibilities of H&E Equipment Services
According to the last published balance sheet, H&E Equipment Services had liabilities of US$182.5 million due within 12 months and liabilities of US$1.59 billion due beyond 12 months. In return, he had $357.3 million in cash and $157.2 million in receivables due within 12 months. Thus, its liabilities outweigh the sum of its cash and (current) receivables by $1.26 billion.
This is a mountain of leverage compared to its market capitalization of US$1.43 billion. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Low interest coverage of 2.3x and an extremely high net debt to EBITDA ratio of 5.8 shook our confidence in H&E Equipment Services like a punch in the gut. The debt burden here is considerable. On the bright side, H&E Equipment Services has increased its EBIT by 37% over the past year. Like the milk of human kindness, this type of growth increases resilience, making the business more capable of managing debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine H&E Equipment Services’ 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 company can only repay its debts with cold hard cash, not with book profits. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, H&E Equipment Services has recorded free cash flow of 88% 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
H&E Equipment Services’ EBIT to free cash flow conversion was a real benefit in this analysis, as was its EBIT growth rate. On the other hand, our confidence was shaken by its apparent struggle to manage its debt, on an EBITDA basis. Looking at all this data, we feel a bit cautious about H&E Equipment Services’ debt levels. While we understand that debt can improve returns on equity, we suggest shareholders keep a close eye on their level of debt, lest it increase. 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 3 warning signs for H&E Equipment Services (1 of which is potentially serious!) that you should know about.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeright now.
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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.