Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Hub Group, Inc. (NASDAQ:HUBG) does use debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Hub Group Carry?
As you can see below, at the end of September 2021, Hub Group had US$258.3m of debt, up from US$236.0m a year ago. Click the image for more detail. On the flip side, it has US$230.7m in cash leading to net debt of about US$27.6m.
How Strong Is Hub Group’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Hub Group had liabilities of US$644.3m due within 12 months and liabilities of US$392.1m due beyond that. On the other hand, it had cash of US$230.7m and US$617.5m worth of receivables due within a year. So its liabilities total US$188.2m more than the combination of its cash and short-term receivables.
Of course, Hub Group has a market capitalization of US$2.91b, so these liabilities are probably manageable. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse. But either way, Hub Group has virtually no net debt, so it’s fair to say it does not have a heavy debt load!
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Hub Group has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.095 and EBIT of 22.7 times the interest expense. So relative to past earnings, the debt load seems trivial. In addition to that, we’re happy to report that Hub Group has boosted its EBIT by 44%, thus reducing the spectre of future debt repayments. There’s no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Hub Group’s ability to maintain a healthy balance sheet going forward.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Hub Group recorded free cash flow worth 73% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Our View
Happily, Hub Group’s impressive interest cover implies it has the upper hand on its debt. And that’s just the beginning of the good news since its EBIT growth rate is also very heartening. We think Hub Group is no more beholden to its lenders, than the birds are to birdwatchers. To our minds it has a healthy happy balance sheet.