Warren Buffett said: “Volatility is far from synonymous with risk”. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Like many other companies Hudson Technologies, Inc. (NASDAQ: HDSN) uses debt. But should shareholders be concerned about its use of debt?
When Is Debt a Problem?
Debts 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. If things really go wrong, lenders can take over the business. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, many companies use debt to finance their growth without negative consequences. When we think of a business’s use of debt, we first look at cash flow and debt together.
How much debt does Hudson Technologies have?
As you can see below, Hudson Technologies had $ 97.1 million in debt in June 2021, up from $ 102.7 million the year before. Net debt is about the same because it doesn’t have a lot of cash.
NasdaqCM: HDSN debt / equity history September 29, 2021
How healthy is Hudson Technologies’ balance sheet?
Zooming in on the latest balance sheet data, we can see that Hudson Technologies had liabilities of US $ 59.9 million due within 12 months and liabilities of US $ 79.6 million due beyond. In compensation for these obligations, it had cash of US $ 1.87 million as well as receivables valued at US $ 33.3 million due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 104.3 million.
This is a mountain of leverage compared to its market capitalization of US $ 160.1 million. This suggests that shareholders would be heavily diluted if the company needed to consolidate its balance sheet quickly.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
While we’re not worried about Hudson Technologies’ 4.3 net debt to EBITDA ratio, we do think its ultra-low 1.4 times interest coverage is a sign of high leverage. It seems clear that the cost of borrowing money is having a negative impact on shareholder returns lately. A buyout factor for Hudson Technologies is that it turned last year’s loss of EBIT into a gain of US $ 16 million over the past twelve months. 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 Hudson Technologies 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 IRS may love accounting profits, lenders only accept hard cash. It is therefore worth checking to what extent earnings before interest and taxes (EBIT) are backed by free cash flow. Over the past year, Hudson Technologies has experienced total negative free cash flow. Debt is much riskier for companies with unreliable free cash flow, so shareholders should hope that past spending will produce free cash flow in the future.
Our point of view
At first glance, Hudson Technologies’ EBIT conversion to free cash flow left us hesitant about the stock, and its interest hedging was no more appealing than the single empty restaurant on the busiest night of the week. ‘year. That said, his ability to increase his EBIT is not that much of a concern. We’re pretty clear that we consider Hudson Technologies to be really rather risky, because of the health of its balance sheet. For this reason, we are quite cautious on the stock, and we believe that shareholders should closely monitor its liquidity. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. For example, we discovered 5 warning signs for Hudson Technologies (2 are potentially serious!) Which you should know before investing here.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash net growth stocks.
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