Howard Marks put it nicely when he said that, rather than worrying about share price volatility, ‘The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Aerojet Rocketdyne Holdings, Inc. (NYSE:AJRD) does carry debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.
See our latest analysis for Aerojet Rocketdyne Holdings
How Much Debt Does Aerojet Rocketdyne Holdings Carry?
The chart below, which you can click on for greater detail, shows that Aerojet Rocketdyne Holdings had US$568.9m in debt in September 2020; about the same as the year before. However, its balance sheet shows it holds US$1.01b in cash, so it actually has US$442.6m net cash.
A Look At Aerojet Rocketdyne Holdings’ Liabilities
We can see from the most recent balance sheet that Aerojet Rocketdyne Holdings had liabilities of US$921.1m falling due within a year, and liabilities of US$1.22b due beyond that. On the other hand, it had cash of US$1.01b and US$547.5m worth of receivables due within a year. So it has liabilities totalling US$586.9m more than its cash and near-term receivables, combined.
Given Aerojet Rocketdyne Holdings has a market capitalization of US$3.99b, it’s hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Aerojet Rocketdyne Holdings boasts net cash, so it’s fair to say it does not have a heavy debt load!
But the other side of the story is that Aerojet Rocketdyne Holdings saw its EBIT decline by 5.2% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Aerojet Rocketdyne Holdings’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Aerojet Rocketdyne Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Aerojet Rocketdyne Holdings actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While Aerojet Rocketdyne Holdings does have more liabilities than liquid assets, it also has net cash of US$442.6m. The cherry on top was that in converted 123% of that EBIT to free cash flow, bringing in US$246m. So we are not troubled with Aerojet Rocketdyne Holdings’s debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we’ve spotted with Aerojet Rocketdyne Holdings .
If, after all that, you’re more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
When trading Aerojet Rocketdyne Holdings or any other investment, use the platform considered by many to be the Professional’s Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account.
This article by Simply Wall St is general in nature. 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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.