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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that ITT Inc. (NYSE:ITT) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is ITT's Net Debt?
The image below, which you can click on for greater detail, shows that ITT had debt of US$193.4m at the end of December 2023, a reduction from US$458.7m over a year. But on the other hand it also has US$489.2m in cash, leading to a US$295.8m net cash position.
How Healthy Is ITT's Balance Sheet?
The latest balance sheet data shows that ITT had liabilities of US$1.04b due within a year, and liabilities of US$355.7m falling due after that. Offsetting these obligations, it had cash of US$489.2m as well as receivables valued at US$701.0m due within 12 months. So it has liabilities totalling US$203.3m more than its cash and near-term receivables, combined.
This state of affairs indicates that ITT's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$10.3b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, ITT also has more cash than debt, so we're pretty confident it can manage its debt safely.
Also good is that ITT grew its EBIT at 18% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if ITT can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. ITT may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, ITT's free cash flow amounted to 36% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Summing Up
While it is always sensible to look at a company's total liabilities, it is very reassuring that ITT has US$295.8m in net cash. And we liked the look of last year's 18% year-on-year EBIT growth. So we don't think ITT's use of debt is risky. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that ITT insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.