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. As with many other companies ITT Inc. (NYSE:ITT) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is ITT's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 ITT had US$547.5m of debt, an increase on US$403.3m, over one year. However, because it has a cash reserve of US$425.5m, its net debt is less, at about US$122.0m.

How Healthy Is ITT's Balance Sheet?

The latest balance sheet data shows that ITT had liabilities of US$1.24b due within a year, and liabilities of US$579.7m falling due after that. On the other hand, it had cash of US$425.5m and US$753.8m worth of receivables due within a year. So its liabilities total US$641.8m more than the combination of its cash and short-term receivables.

Since publicly traded ITT shares are worth a very impressive total of US$10.6b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Carrying virtually no net debt, ITT has a very light debt load indeed.

In order to size up 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). 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).

ITT's net debt is only 0.18 times its EBITDA. And its EBIT covers its interest expense a whopping 36.8 times over. So we're pretty relaxed about its super-conservative use of debt. Also good is that ITT grew its EBIT at 10% over the last year, further increasing its ability to manage debt. 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 ITT'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, ITT recorded free cash flow worth 62% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, ITT's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its net debt to EBITDA is also very heartening. Looking at the bigger picture, we think ITT's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that ITT insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com