Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that BWX Technologies, Inc. (NYSE:BWXT) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is BWX Technologies's Net Debt?
The image below, which you can click on for greater detail, shows that BWX Technologies had debt of US$1.21b at the end of June 2024, a reduction from US$1.34b over a year. However, it also had US$48.3m in cash, and so its net debt is US$1.16b.
How Healthy Is BWX Technologies' Balance Sheet?
According to the last reported balance sheet, BWX Technologies had liabilities of US$408.6m due within 12 months, and liabilities of US$1.43b due beyond 12 months. Offsetting this, it had US$48.3m in cash and US$783.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.01b.
Since publicly traded BWX Technologies shares are worth a very impressive total of US$10.4b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
With net debt to EBITDA of 2.8 BWX Technologies has a fairly noticeable amount of debt. But the high interest coverage of 8.0 suggests it can easily service that debt. One way BWX Technologies could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 13%, as it did over the last year. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine BWX Technologies's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, BWX Technologies's free cash flow amounted to 37% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Our View
Both BWX Technologies's ability to to grow its EBIT and its interest cover gave us comfort that it can handle its debt. Having said that, its net debt to EBITDA somewhat sensitizes us to potential future risks to the balance sheet. When we consider all the elements mentioned above, it seems to us that BWX Technologies is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that BWX Technologies is showing 1 warning sign in our investment analysis , you should know about...
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.