These 4 metrics indicate that Hexagon (STO:HEXA B) is using debt reasonably well
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. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We note that Hexagon AB (released) (STO:HEXA B) has a debt on its balance sheet. But the real question is whether this debt makes the business risky.
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. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we look at debt levels, we first consider cash and debt levels, together.
Check out our latest analysis for Hexagon
What is Hexagon’s debt?
You can click on the graph below for historical numbers, but it shows that in March 2022, Hexagon had 2.84 billion euros in debt, an increase from 2.31 billion euros, on a year. On the other hand, he has €698.2 million in cash, resulting in a net debt of around €2.15 billion.
A Look at Hexagon’s Responsibilities
Zooming in on the latest balance sheet data, we can see that Hexagon had liabilities of €2.30 billion due within 12 months and liabilities of €3.26 billion due beyond. On the other hand, it had cash of €698.2 million and €1.20 billion in receivables at less than one year. It therefore has liabilities totaling 3.66 billion euros more than its cash and short-term receivables, combined.
Given that publicly traded Hexagon shares are worth a very impressive total of 26.6 billion euros, it seems unlikely that this level of liabilities will pose a major threat. That said, it is clear that we must continue to monitor its record, lest it deteriorate.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
Hexagon has a low net debt to EBITDA ratio of just 1.5. And its EBIT easily covers its interest charges, being 99 times greater. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. And we also warmly note that Hexagon increased its EBIT by 11% last year, which makes it easier to manage its debt. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Hexagon can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
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, Hexagon has recorded free cash flow of 73% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This cold hard cash allows him to reduce his debt whenever he wants.
Our point of view
Hexagon’s interest coverage suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. And the good news does not stop there, since its conversion of EBIT into free cash flow also confirms this impression! Zooming out, Hexagon appears to be using debt quite sensibly; and that gets the green light from us. Although debt carries risks, when used wisely, it can also generate a higher return on equity. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Be aware that Hexagon displays 3 warning signs in our investment analysis 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.
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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.