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Legendary fund manager Li Lu (who 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. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Kratos Defense & Security Solutions, Inc. (NASDAQ:KTOS) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. If things get really bad, the lenders can take control of the business. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
View our latest analysis for Kratos Defense & Security Solutions
What Is Kratos Defense & Security Solutions's Net Debt?
The chart below, which you can click on for greater detail, shows that Kratos Defense & Security Solutions had US$294.6m in debt in June 2019; about the same as the year before. On the flip side, it has US$176.2m in cash leading to net debt of about US$118.4m.
How Healthy Is Kratos Defense & Security Solutions's Balance Sheet?
We can see from the most recent balance sheet that Kratos Defense & Security Solutions had liabilities of US$188.9m falling due within a year, and liabilities of US$409.8m due beyond that. Offsetting these obligations, it had cash of US$176.2m as well as receivables valued at US$236.9m due within 12 months. So it has liabilities totalling US$185.6m more than its cash and near-term receivables, combined.
Of course, Kratos Defense & Security Solutions has a market capitalization of US$2.18b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).