David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Above all, KBR, Inc. (NYSE:KBR) is in debt. But does this debt worry shareholders?
What risk does debt carry?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for KBR
What is KBR’s net debt?
The image below, which you can click on for more details, shows that in March 2022, KBR had $1.89 billion in debt, up from $1.63 billion in one year. However, since it has a cash reserve of $414.0 million, its net debt is less, at around $1.48 billion.
How healthy is KBR’s balance sheet?
The latest balance sheet data shows that KBR had liabilities of $1.46 billion due within the year, and liabilities of $2.60 billion due thereafter. As compensation for these obligations, it had cash of US$414.0 million and receivables valued at US$1.25 billion due within 12 months. Thus, its liabilities outweigh the sum of its cash and (current) receivables by $2.40 billion.
This shortfall is not that bad as KBR is worth US$6.48 billion and therefore could probably raise enough capital to shore up its balance sheet, should the need arise. But it is clear that it is essential to examine closely whether it can manage its debt without dilution.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). Thus, we consider debt to earnings with and without amortization and depreciation expense.
KBR’s debt represents 2.8 times its EBITDA and its EBIT covers its interest charges 4.5 times. Taken together, this implies that, while we wouldn’t like to see debt levels increase, we think he can manage his current leverage. It should be noted that KBR’s EBIT jumped like bamboo after rain, gaining 32% over the last twelve months. This will make it easier to manage your debt. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether KBR can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, while the taxman may love accounting profits, lenders only accept cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, KBR has recorded free cash flow of 80% of its EBIT, which is higher than what we would normally expect. This positions him well to pay off debt if desired.
Our point of view
The good news is that KBR’s demonstrated ability to convert EBIT into free cash flow delights us like a fluffy puppy does a toddler. But, on a darker note, we’re a bit concerned about its net debt to EBITDA. When we consider the range of factors above, it seems that KBR is quite sensitive with its use of debt. While this carries some risk, it can also improve shareholder returns. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Be aware that KBR displays 2 warning signs in our investment analysis and 1 of them concerns…
If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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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.