Timken (NYSE:TKR) takes on some risk by using debt

Howard Marks summed it up when he said: “Instead of worrying about share price volatility, the possibility of permanent loss is the risk I worry about… and every practical investor I know worries about “When we think about how risky a company is, we always look at the use of debt, because over-indebtedness can lead to ruin. What is important is The Timken Company (NYSE:TKR) carries debt. But is this debt a problem for shareholders?

What risk does debt bring with it?

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. Of course, many companies use debt to finance their growth without any negative consequences. When we examine debt levels, we first consider both cash and debt levels together.

Check out our latest analysis for Timken

How much is Timken’s net debt?

The chart below, which you can click on for more detail, shows that Timken had $2.23 billion in debt as of September 2024; about the same as the year before. On the other hand, the company has cash of $412.7 million, leading to net debt of about $1.82 billion.

How strong is Timken’s balance sheet?

The latest balance sheet data shows that Timken had liabilities of US$910.3m within a year, and liabilities of US$2.77b falling due after that. On the other hand, it had cash of US$412.7m and US$924.6m worth of receivables due within a year. So its liabilities total US$2.34b more than its cash and short-term receivables combined.

While that may seem like a lot, it’s not that bad since Timken has a market cap of $5.39 billion and the company could likely strengthen its balance sheet by raising capital if necessary. But it’s clear that we should definitely take a close look at whether it can manage its debt without dilution.

We use two main ratios to inform us about the level of debt relative to profits. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times earnings before interest and tax (EBIT) cover interest expense (or interest cover, for short). . The advantage of this approach is that we take into account both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio).

Timken’s net debt is a very reasonable 2.3 times its EBITDA, while its EBIT covered just 5.1 times its interest expense last year. While that doesn’t worry us too much, it does suggest that the interest payments are a bit of a burden. Shareholders should be aware that Timken’s EBIT fell 24% last year. If this decline continues, paying off the debt will be harder than selling foie gras at a vegan conference. The balance sheet is clearly the area to focus on when analyzing debt. Ultimately, however, the company’s future profitability will determine whether Timken can strengthen its balance sheet over time. So if you’re focused on the future, you can look at that free Report with analyst profit forecasts.

After all, a company needs free cash flow to pay off debt; Book profits are simply not enough. So it’s worth checking how much of that EBIT is covered by free cash flow. Looking over the last three years, Timken recorded free cash flow worth 45% of its EBIT, which is weaker than we’d expect. That’s not great when it comes to paying off debt.

Our view

When we think about Timken’s attempt to (not) grow its EBIT, we’re certainly not thrilled. But at least the interest coverage isn’t that bad. When we consider all of the above factors together, it seems to us that Timken’s debt makes the company somewhat risky. Some people like this kind of risk, but we are aware of the potential pitfalls and would therefore probably prefer the debt to be lower. There is no doubt that the balance sheet is where we learn the most about debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We’ve identified two warning signs with Timken (at least 1, which is significant) and understanding them should be part of your investment process.

If you’re interested in investing in companies that can grow profits without the burden of debt, then check this out free List of growing companies that have net cash on the balance sheet.

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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 position in any stocks mentioned.