We believe Halliburton (NYSE: HAL) is taking risks with its debt
Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital”. It is only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. We can see that Halliburton Company (NYSE: HAL) uses debt in its business. But does this debt concern shareholders?
When Is Debt a Problem?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. If things really go wrong, lenders can take over the business. However, a more common (but still painful) scenario is that he must raise new equity at low cost, thereby diluting shareholders over the long term. 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.
What is Halliburton’s net debt?
The graph below, which you can click for more details, shows Halliburton owed $ 9.64 billion in debt as of June 2021; about the same as the year before. However, it has $ 2.66 billion in cash offsetting that, leading to net debt of around $ 6.98 billion.
NYSE: HAL Debt to Equity History September 26, 2021
How healthy is Halliburton’s track record?
According to the latest published balance sheet, Halliburton had liabilities of US $ 4.33 billion due within 12 months and liabilities of US $ 11.2 billion due beyond 12 months. On the other hand, it had US $ 2.66 billion in cash and US $ 3.46 billion in receivables due within one year. Its liabilities therefore total $ 9.37 billion more than the combination of its cash and short-term receivables.
While that might sound like a lot, it’s not that big of a deal since Halliburton has a massive market cap of US $ 18.7 billion, and therefore could likely strengthen its balance sheet by raising capital if needed. But we absolutely want to keep our eyes open for indications that its debt is too risky.
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). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
While we’re not worried about Halliburton’s 4.5 net debt to EBITDA ratio, we do think its ultra-low 1.3x interest coverage is a sign of high leverage. This is in large part due to the company’s large depreciation and amortization charges, which arguably means that its EBITDA is a very generous measure of profit, and its debt may be heavier than it appears. At first glance. It seems clear that the cost of borrowing money is having a negative impact on shareholder returns lately. Worse yet, Halliburton has seen its EBIT reach 51% over the past 12 months. If the income continues like this for the long haul, there is an incredible chance to pay off that debt. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Halliburton can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Halliburton has generated strong free cash flow equivalent to 73% of its EBIT, roughly what we expected. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
To be frank, Halliburton’s interest coverage and track record of (not) growing its EBIT makes us rather uncomfortable with its debt levels. But at least it’s pretty decent to convert EBIT into free cash flow; it’s encouraging. Looking at the balance sheet and taking all of these factors into account, we think debt makes Halliburton stock a bit risky. This isn’t necessarily a bad thing, but we would generally feel more comfortable with less leverage. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we discovered 3 warning signs for Halliburton (1 cannot be ignored!) Which you should be aware of before investing here.
If you are interested in investing in companies that can generate profits without the burden of debt, check out this page free list of growing companies that have net cash on the balance sheet.
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