Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We note that EnerSys (NYSE:ENS) has debt on its balance sheet. But the more important question is: what risk does this debt create?
When is debt a problem?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for EnerSys
What is EnerSys’ net debt?
You can click on the chart below for historical numbers, but it shows that in January 2022, EnerSys had $1.22 billion in debt, an increase from $1.09 billion, year-over-year . However, he also had $397.1 million in cash, so his net debt is $827.9 million.
How strong is EnerSys’ balance sheet?
We can see from the most recent balance sheet that EnerSys had liabilities of US$622.1 million due in one year, and liabilities of US$1.46 billion due beyond. In return, it had $397.1 million in cash and $636.0 million in receivables due within 12 months. Thus, its liabilities total $1.05 billion more than the combination of its cash and short-term receivables.
While that might sound like a lot, it’s not too bad since EnerSys has a market capitalization of US$2.95 billion, so it could probably bolster its balance sheet by raising capital if needed. But it is clear that it must be carefully examined whether he can manage his debt without dilution.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
EnerSys’ net debt is at a very reasonable 2.4 times its EBITDA, while its EBIT covered its interest charges at only 6.5 times last year. While these numbers don’t alarm us, it’s worth noting that the cost of corporate debt has a real impact. EnerSys increased its EBIT by 3.1% over the past year. While that barely brings us down, it’s a positive when it comes to debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine EnerSys’ ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the last three years, EnerSys has recorded a free cash flow of 44% of its EBIT, which is lower than expected. This low cash conversion makes debt management more difficult.
Our point of view
EnerSys’ interest coverage is a real bright spot in this analysis, as is its EBIT growth rate. That said, its net debt to EBITDA makes us somewhat aware of potential future risks to the balance sheet. When we consider all the factors mentioned above, we feel a bit cautious about EnerSys’ use of debt. While we understand that debt can improve returns on equity, we suggest shareholders keep a close eye on their level of debt, lest it increase. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. Be aware that EnerSys displays 2 warning signs in our investment analysis and 1 of them does not suit us too much…
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.