Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Lockheed Martin Corporation (NYSE:LMT) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
The image below, which you can click on for greater detail, shows that at December 2024 Lockheed Martin had debt of US$20.3b, up from US$17.5b in one year. However, it does have US$2.48b in cash offsetting this, leading to net debt of about US$17.8b.
NYSE:LMT Debt to Equity History February 10th 2025
How Healthy Is Lockheed Martin's Balance Sheet?
The latest balance sheet data shows that Lockheed Martin had liabilities of US$19.4b due within a year, and liabilities of US$29.9b falling due after that. Offsetting these obligations, it had cash of US$2.48b as well as receivables valued at US$15.3b due within 12 months. So its liabilities total US$31.5b more than the combination of its cash and short-term receivables.
This deficit isn't so bad because Lockheed Martin is worth a massive US$104.6b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
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).
Lockheed Martin's net debt is sitting at a very reasonable 2.1 times its EBITDA, while its EBIT covered its interest expense just 6.9 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Importantly, Lockheed Martin's EBIT fell a jaw-dropping 21% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Lockheed Martin's ability to maintain a healthy balance sheet going forward. 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Lockheed Martin produced sturdy free cash flow equating to 74% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Our View
Lockheed Martin's EBIT growth rate was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example its conversion of EBIT to free cash flow was refreshing. We think that Lockheed Martin's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Lockheed Martin you should be aware of.
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.
Have feedback on this article? Concerned about the content?Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
