Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘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. As with many other companies Spirit AeroSystems Holdings, Inc. (NYSE:SPR) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is Spirit AeroSystems Holdings’s Net Debt?
The image below, which you can click on for greater detail, shows that at July 2021 Spirit AeroSystems Holdings had debt of US$3.42b, up from US$3.27b in one year. However, it does have US$1.27b in cash offsetting this, leading to net debt of about US$2.15b.
How Healthy Is Spirit AeroSystems Holdings’ Balance Sheet?
We can see from the most recent balance sheet that Spirit AeroSystems Holdings had liabilities of US$1.53b falling due within a year, and liabilities of US$5.65b due beyond that. On the other hand, it had cash of US$1.27b and US$1.18b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$4.73b.
When you consider that this deficiency exceeds the company’s US$4.49b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. There’s no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Spirit AeroSystems Holdings can strengthen its balance sheet over time.
In the last year Spirit AeroSystems Holdings had a loss before interest and tax, and actually shrunk its revenue by 36%, to US$3.6b. That makes us nervous, to say the least.
While Spirit AeroSystems Holdings’s falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost US$379m at the EBIT level. When we look at that alongside the significant liabilities, we’re not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through US$504m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. There’s no doubt that we learn most about debt from the balance sheet.