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. 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, Black Hills Society (NYSE:BKH) is in debt. But the real question is whether this debt makes the business risky.
Why is debt risky?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we look at debt levels, we first consider cash and debt levels, together.
See our latest analysis for Black Hills
How much debt does Black Hills have?
The graph below, which you can click on for more details, shows that Black Hills had $4.47 billion in debt as of March 2022; about the same as the previous year. Net debt is about the same, since she doesn’t have a lot of cash.
A Look at Black Hills Responsibilities
Zooming in on the latest balance sheet data, we can see that Black Hills had liabilities of US$794.7 million due within 12 months and liabilities of US$5.36 billion due beyond. On the other hand, it had $16.3 million in cash and $401.8 million in receivables due within a year. Thus, its liabilities outweigh the sum of its cash and (current) receivables by $5.74 billion.
Given that this deficit is actually greater than the company’s market cap of $4.70 billion, we think shareholders really should be watching Black Hills’ debt levels, like a parent watching their child do. cycling for the first time. In the scenario where the company were to quickly clean up its balance sheet, it seems likely that shareholders would suffer significant dilution.
We measure a company’s leverage against its earning power 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 charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
With a net debt to EBITDA ratio of 6.5, it’s fair to say that Black Hills has significant debt. But the good news is that it has a pretty heartwarming 2.9x interest coverage, suggesting it can meet its obligations responsibly. Fortunately, Black Hills has grown its EBIT by 6.9% over the past year, slowly reducing its debt to earnings ratio. 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 Black Hills 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.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Black Hills has had substantial negative free cash flow, in total. While investors no doubt expect a reversal of this situation in due course, this clearly means that its use of debt is more risky.
Our point of view
At first glance, Black Hills’ net debt to EBITDA ratio left us hesitant about the stock, and its EBIT-to-free-cash-flow conversion was no more appealing than the single empty restaurant the night before. busiest of the year. But at least it’s decent enough to increase its EBIT; it’s encouraging. It should also be noted that companies in the integrated utility sector like Black Hills generally use debt without issue. We are quite clear that we consider Black Hills to be quite risky indeed, given the health of its balance sheet. For this reason, we are quite cautious about the stock and believe shareholders should keep a close eye on its liquidity. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. Example: we have identified 3 warning signs for Black Hills you need to be aware of, and 1 of them should not be ignored.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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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.