David Iben expressed it well when he said: âVolatility is not a risk that is close to our hearts. What matters to us is to avoid the permanent loss of 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 note that Xylem Inc. (NYSE: XYL) has debt on its balance sheet. But does this debt worry shareholders?
When is debt a problem?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. 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. When we look at debt levels, we first consider both liquidity and debt levels.
What is Xylem’s debt?
The image below, which you can click for more details, shows that Xylem had a debt of US $ 3.07 billion at the end of June 2021, a reduction from US $ 3.24 billion on a year. However, he also had $ 1.84 billion in cash, so his net debt is $ 1.23 billion.
NYSE: XYL Debt to Equity History October 5, 2021
How strong is Xylem’s balance sheet?
The latest balance sheet data shows that Xylem had liabilities of US $ 1.96 billion due within one year, and liabilities of US $ 3.78 billion due thereafter. On the other hand, he had $ 1.84 billion in cash and $ 975.0 million in receivables due within a year. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 2.92 billion.
Of course, Xylem has a titanic market cap of $ 21.5 billion, so those liabilities are likely manageable. But there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward.
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 charges.
Xylem has net debt of only 1.4 times EBITDA, indicating that he is certainly not a reckless borrower. And this view is underpinned by the strong interest coverage, with EBIT reaching 8.0 times the interest expense of last year. Another good thing is that Xylem has increased its EBIT to 15% over the past year, further increasing its ability to manage debt. There is no doubt that we learn the most about debt from the balance sheet. But it is future profits, more than anything, that will determine Xylem’s ability to maintain a healthy balance sheet in the future. 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, Xylem has recorded free cash flow totaling 88% of its EBIT, which is higher than what we would normally expect. This puts him in a very strong position to pay off the debt.
Our point of view
The good news is that Xylem’s demonstrated ability to convert EBIT into free cash flow delights us like a fluffy puppy does a toddler. And that’s just the start of the good news as its EBIT growth rate is also very encouraging. Zooming out, Xylem seems to be using the debt in a very reasonable way; and that gets the nod from us. While debt comes with risk, when used wisely, it can also generate a better return on equity. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. Concrete example: we have spotted 2 warning signs for Xylem 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 net growth stocks.
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