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.’ So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. We note that Halliburton Company (NYSE:HAL) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company’s use of debt, we first look at cash and debt together.
What Is Halliburton’s Debt?
As you can see below, Halliburton had US$9.13b of debt at December 2021, down from US$9.83b a year prior. On the flip side, it has US$3.04b in cash leading to net debt of about US$6.09b.
A Look At Halliburton’s Liabilities
We can see from the most recent balance sheet that Halliburton had liabilities of US$4.31b falling due within a year, and liabilities of US$11.3b due beyond that. On the other hand, it had cash of US$3.04b and US$3.67b worth of receivables due within a year. So it has liabilities totalling US$8.88b more than its cash and near-term receivables, combined.
Halliburton has a very large market capitalization of US$37.5b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Halliburton has net debt worth 2.3 times EBITDA, which isn’t too much, but its interest cover looks a bit on the low side, with EBIT at only 3.7 times the interest expense. While that doesn’t worry us too much, it does suggest the interest payments are somewhat of a burden. Notably, Halliburton’s EBIT launched higher than Elon Musk, gaining a whopping 202% on last year. 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 Halliburton can strengthen its balance sheet over time.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Halliburton recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we’d usually expect. That puts it in a very strong position to pay down debt.
Our View
Happily, Halliburton’s impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its interest cover. When we consider the range of factors above, it looks like Halliburton is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. There’s no doubt that we learn most about debt from the balance sheet.