Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ 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 can see that EnerSys (NYSE:ENS) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company’s debt levels is to consider its cash and debt together.
How Much Debt Does EnerSys Carry?
The image below, which you can click on for greater detail, shows that at June 2019 EnerSys had debt of US$1.00b, up from US$609.3m in one year. However, it does have US$262.1m in cash offsetting this, leading to net debt of about US$740.7m.
How Healthy Is EnerSys’s Balance Sheet?
According to the last reported balance sheet, EnerSys had liabilities of US$598.9m due within 12 months, and liabilities of US$1.29b due beyond 12 months. Offsetting this, it had US$262.1m in cash and US$621.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.00b.
While this might seem like a lot, it is not so bad since EnerSys has a market capitalization of US$2.80b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
With a debt to EBITDA ratio of 2.1, EnerSys uses debt artfully but responsibly. And the fact that its trailing twelve months of EBIT was 7.9 times its interest expenses harmonizes with that theme. Notably EnerSys’s EBIT was pretty flat over the last year. Ideally it can diminish its debt load by kick-starting earnings growth. There’s no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine EnerSys’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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, EnerSys’s free cash flow amounted to 50% of its EBIT, less than we’d expect. That’s not great, when it comes to paying down debt.
When it comes to the balance sheet, the standout positive for EnerSys was the fact that it seems able to cover its interest expense with its EBIT confidently. But the other factors we noted above weren’t so encouraging. For example, its level of total liabilities makes us a little nervous about its debt. Looking at all this data makes us feel a little cautious about EnerSys’s debt levels. While we appreciate debt can enhance returns on equity, we’d suggest that shareholders keep close watch on its debt levels, lest they increase. Of course, we wouldn’t say no to the extra confidence that we’d gain if we knew that EnerSys insiders have been buying shares: if you’re on the same wavelength, you can find out if insiders are buying by clicking this link.
If, after all that, you’re more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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