Leidos Holdings (NYSE:LDOS) appears to be using its debt quite wisely

Legendary fund manager Li Lu (whom Charlie Munger backed) once said: “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 look We always recommend the use of debt, because over-indebtedness can lead to ruin. We can see that Leidos Holdings, Inc. (NYSE:LDOS) uses debt in its business. But is this debt a problem for shareholders?

When is debt dangerous?

Debt helps a business until the business has difficulty paying it off, whether with new capital or free cash flow. If things get really bad, the lenders can take control of the business. While this isn’t all that common, we often see indebted companies permanently diluting their shareholders because lenders force them to raise capital at a distressed price. However, the most common situation is for a company to manage its debt reasonably well – and to its own advantage. When we think about a company’s use of debt, we first consider cash and debt together.

Check out our latest analysis for Leidos Holdings

How much debt does Leidos Holdings have?

The chart below, which you can click on for more details, shows that Leidos Holdings had $4.60 billion in debt as of September 2024; about the same as the year before. However, the company also had $1.19 billion in cash, leaving its net debt at $3.41 billion.

A look at Leidos Holdings’ liabilities

According to the last reported balance sheet, Leidos Holdings had liabilities of US$3.78b due within 12 months, and liabilities of US$4.89b due beyond 12 months. On the other hand, it had cash of US$1.19b and US$2.71b worth of receivables due within a year. So its liabilities total US$4.78 billion more than the combination of its cash and short-term receivables.

This deficit isn’t that bad since Leidos Holdings is worth a massive US$22.1 billion, and therefore could probably raise enough capital to support its balance sheet if needed. Nevertheless, it is worth taking a close look at your ability to repay your debts.

To measure a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). We take into account both the absolute amount of the debt and the interest paid on it.

Leidos Holdings’ net debt of 1.7 times EBITDA suggests that its debt is being used wisely. And the tempting interest coverage (EBIT of 9.0 times interest expenses) definitely does not do everything you can to dispel this impression. Additionally, Leidos Holdings grew its EBIT by 42% over the last twelve months, and this growth will make it easier to manage its debt. When analyzing debt levels, the balance sheet is the obvious place to start. However, the company’s future profitability will ultimately determine whether Leidos Holdings 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.

After all, a company needs free cash flow to pay off debt. Book profits are simply not enough. So the logical step is to examine the proportion of that EBIT that corresponds to actual free cash flow. Over the last three years, Leidos Holdings produced stable free cash flow accounting for 74% of its EBIT, which is about what we would expect. This cold hard cash means it can pay down its debt whenever it wants.

Our view

The good news is that Leidos Holdings’ proven ability to grow its EBIT delights us like a fluffy puppy delights a toddler. And that’s just the beginning of the good news, as the conversion of EBIT to free cash flow is also very encouraging. When you strip it down, Leidos Holdings appears to be using debt quite sensibly; and that deserves our praise. Finally, sensible leverage can increase return on equity. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we discovered it 1 warning sign for Leidos Holdings what you should be aware of before investing here.

If, after all that, you’re more interested in a fast-growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks immediately.

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This article from Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts using only an unbiased methodology and our articles are not intended as financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term focused analysis based on fundamental data. Note that our analysis may not reflect the latest price-sensitive company announcements or qualitative material. Simply Wall St has no positions in any stocks mentioned.