David Iben put it right when he said: “Volatility is not a risk that is close to our hearts. What matters to us is to avoid the permanent loss of capital. It is natural to consider a company’s balance sheet when considering how risky it is, as debt is often involved when a business collapses. We can see that Harley-Davidson, Inc. (NYSE: HOG) uses debt in its business. But should shareholders be concerned about its use of debt?
When is debt a problem?
Debt and other liabilities become risky for a business when it cannot easily meet these 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 he has to raise new equity at low cost, thereby constantly diluting shareholders. 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. When we think of a business’s use of debt, we first look at cash flow and debt together.
See our latest review for Harley-Davidson
What is Harley-Davidson’s net debt?
As you can see below, Harley-Davidson was in debt of US $ 7.87 billion in March 2021, which is roughly the same as the year before. You can click on the graph for more details. On the other hand, it has US $ 607.9 million in cash, which leads to net debt of around US $ 7.26 billion.
How strong is Harley-Davidson’s balance sheet?
We can see from the most recent balance sheet that Harley-Davidson had liabilities of US $ 3.45 billion maturing in one year and liabilities of US $ 5.91 billion beyond. In contrast, it had US $ 607.9 million in cash and US $ 216.6 million in receivables due within one year. Its liabilities are therefore $ 8.54 billion more than the combination of its cash and short-term receivables.
Given that this deficit is actually greater than the company’s market cap of US $ 7.16 billion, we think shareholders should really watch Harley-Davidson’s debt levels, like a parent watching their child. riding a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely that shareholders would suffer significant dilution.
In order to size a company’s debt against its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest expense. (its interest coverage). Thus, we consider debt versus earnings with and without amortization charges.
In this case, Harley-Davidson has a fairly worrying net debt / EBITDA ratio of 13.1 but very strong interest coverage of 17.0. This means that unless the business has access to very cheap debt, these interest charges will likely increase in the future. Shareholders should know that Harley-Davidson’s EBIT fell 30% last year. If this earnings trend continues, paying off debt will be about as easy as raising cats on a roller coaster. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future profits, more than anything, that will determine Harley-Davidson’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future you can check out this free report showing analysts’ earnings forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits do not reduce it. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, Harley-Davidson has actually produced more free cash flow than EBIT. This kind of strong cash generation warms our hearts like a puppy in a bumblebee costume.
Our point of view
At first glance, Harley-Davidson’s net debt to EBITDA left us hesitant about the stock, and its EBIT growth rate was no more attractive than the only empty restaurant on the night before. busiest of the year. But on the bright side, his coverage of interest is a good sign and makes us more optimistic. Looking at the balance sheet and taking all of these factors into account, we think debt makes Harley-Davidson stock a bit risky. Some people like this type of risk, but we are aware of the potential pitfalls, so we would probably prefer it to be less in debt. 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. We have identified 4 warning signs with Harley-Davidson (at least 1 which makes us a little uncomfortable), and understanding them should be part of your investment process.
Of course, if you are the type of investor who prefers to buy stocks without the burden of debt, feel free to check out our exclusive list of cash net growth stocks today.
If you are looking to trade in Harley-Davidson, open an account with the cheapest * professionally approved platform, Interactive brokers. Their clients from more than 200 countries and territories trade stocks, options, futures, currencies, bonds and funds around the world from a single integrated account.
This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell stocks and does not take into account your goals or your financial situation. We aim to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative information. Simply Wall St has no position in the mentioned stocks.
*Interactive Brokers ranked Least Expensive Broker by StockBrokers.com Annual Online Review 2020
Do you have any comments on this article? Concerned about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.