Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say this when he says “The biggest risk in investing is not price volatility, but if you will suffer a loss. permanent capital “. So it can be obvious that you need to consider debt, when you think about how risky a given stock is, because too much debt can sink a business. We notice that Cummins Inc. (NYSE: CMI) has debt on its balance sheet. But the most important question is: what risk does this debt create?
When is debt dangerous?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. Of course, debt can be an important tool in businesses, especially capital intensive businesses. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
How much debt does Cummins have?
You can click on the graph below for historical figures, but it shows Cummins owed US $ 3.86 billion in debt as of October 2021, up from US $ 4.11 billion a year earlier. However, given that it has a cash reserve of US $ 3.02 billion, its net debt is less, at around US $ 840.0 million.
NYSE: CMI Debt to Equity History December 24, 2021
How strong is Cummins’ balance sheet?
According to the latest published balance sheet, Cummins had liabilities of US $ 6.86 billion due within 12 months and liabilities of US $ 7.20 billion due beyond 12 months. On the other hand, it had US $ 3.02 billion in cash and US $ 4.15 billion in receivables due within one year. It therefore has liabilities totaling US $ 6.89 billion more than its cash and short-term receivables combined.
Cummins has a very large market capitalization of US $ 30.6 billion, so it could most likely raise funds to improve its balance sheet, should the need arise. But it is clear that it is absolutely necessary to take a close look at whether it can manage its debt without dilution.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). Thus, we consider debt versus earnings with and without amortization expenses.
Cummins has a low net debt to EBITDA ratio of just 0.27. And its EBIT easily covers its interest costs, being 27.0 times higher. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. On top of that, Cummins has increased its EBIT by 35% over the past twelve months, and this growth will make it easier to process its debt. 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 Cummins can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Cummins has generated free cash flow of 89% of its very robust EBIT, more than we expected. This positions it well to repay debt if it is desirable.
Our point of view
Fortunately, Cummins’ impressive interest coverage means it has the upper hand on its debt. And this is only the beginning of good news as its conversion from EBIT to free cash flow is also very encouraging. Considering this array of factors, it seems to us that Cummins is fairly conservative with its debt, and the risks appear to be well managed. The balance sheet therefore seems rather healthy to us. When analyzing debt levels, the balance sheet is the obvious place to start. However, not all investment risks lie on the balance sheet – far from it. Concrete example: we have spotted 1 warning sign for Cummins you must be aware.
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-flow net-growth stocks.
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