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.” It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We note that Eagle Materials Inc. (NYSE:EXP) has debt on its balance sheet. But does this debt worry shareholders?
When is debt dangerous?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we think about a company’s use of debt, we first look at cash and debt together.
Check out our latest analysis for Eagle Materials
How much debt does Eagle Materials have?
The image below, which you can click on for more details, shows Eagle Materials had $837.9 million in debt at the end of December 2021, a reduction from $1.01 billion year-over-year . On the other hand, he has $17.4 million in cash, resulting in a net debt of around $820.6 million.
A Look at Eagle Materials’ Responsibilities
According to the last published balance sheet, Eagle Materials had liabilities of $193.7 million due within 12 months and liabilities of $1.14 billion due beyond 12 months. On the other hand, it had $17.4 million in cash and $179.6 million in receivables within one year. Thus, its liabilities total $1.14 billion more than the combination of its cash and short-term receivables.
This shortfall is not that bad as Eagle Materials is worth $4.87 billion and therefore could probably raise enough capital to shore up its balance sheet, should the need arise. But it is clear that it must be carefully examined whether he can manage his debt without dilution.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Eagle Materials’ net debt is only 1.4 times its EBITDA. And its EBIT easily covers its interest costs, which is 14.9 times the size. So we’re pretty relaxed about his super conservative use of debt. Also positive, Eagle Materials has grown its EBIT by 26% over the past year, which should make it easier to pay down debt in the future. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Eagle Materials can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, while the taxman may love accounting profits, lenders only accept cash. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Eagle Materials has actually produced more free cash flow than EBIT. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our point of view
The good news is that Eagle Materials’ demonstrated ability to cover its interest costs with its EBIT delights us like a fluffy puppy does a toddler. And this is only the beginning of good news since its conversion of EBIT into free cash flow is also very pleasing. Zooming out, Eagle Materials seems to be using debt quite sensibly; and that gets the green light from us. Although debt carries risks, when used wisely, it can also generate a higher return on equity. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 1 warning sign for Eagle Materials you should know.
If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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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.