Hammond Power Solutions (TSE:HPS.A) Has A Rock Solid Balance Sheet

Simply Wall St

Sun, Apr 10, 2022, 8:47 AM 4 min read

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Hammond Power Solutions Inc. (TSE:HPS.A) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Hammond Power Solutions

How Much Debt Does Hammond Power Solutions Carry?

The image below, which you can click on for greater detail, shows that at December 2021 Hammond Power Solutions had debt of CA$19.3m, up from CA$16.1m in one year. However, it does have CA$20.9m in cash offsetting this, leading to net cash of CA$1.64m.

debt-equity-history-analysis — TSX:HPS.A Debt to Equity History April 10th 2022

How Strong Is Hammond Power Solutions' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hammond Power Solutions had liabilities of CA$102.0m due within 12 months and liabilities of CA$7.10m due beyond that. Offsetting these obligations, it had cash of CA$20.9m as well as receivables valued at CA$73.0m due within 12 months. So it has liabilities totalling CA$15.2m more than its cash and near-term receivables, combined.

Given Hammond Power Solutions has a market capitalization of CA$153.9m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Hammond Power Solutions boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Hammond Power Solutions has boosted its EBIT by 66%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Hammond Power Solutions can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Hammond Power Solutions has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Hammond Power Solutions generated free cash flow amounting to a very robust 82% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

We could understand if investors are concerned about Hammond Power Solutions's liabilities, but we can be reassured by the fact it has has net cash of CA$1.64m. And it impressed us with free cash flow of CA$14m, being 82% of its EBIT. So is Hammond Power Solutions's debt a risk? It doesn't seem so to us. Another factor that would give us confidence in Hammond Power Solutions would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.