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. Importantly, Spirax-Sarco Engineering plc (LON:SPX) does carry debt. But the real question is whether this debt is making the company risky.
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for Spirax-Sarco Engineering
What Is Spirax-Sarco Engineering's Net Debt?
The image below, which you can click on for greater detail, shows that Spirax-Sarco Engineering had debt of UKĀ£405.1m at the end of December 2021, a reduction from UKĀ£475.0m over a year. However, because it has a cash reserve of UKĀ£274.6m, its net debt is less, at about UKĀ£130.5m.
How Strong Is Spirax-Sarco Engineering's Balance Sheet?
According to the last reported balance sheet, Spirax-Sarco Engineering had liabilities of UKĀ£381.7m due within 12 months, and liabilities of UKĀ£471.5m due beyond 12 months. Offsetting these obligations, it had cash of UKĀ£274.6m as well as receivables valued at UKĀ£308.9m due within 12 months. So it has liabilities totalling UKĀ£269.7m more than its cash and near-term receivables, combined.
Given Spirax-Sarco Engineering has a market capitalization of UKĀ£7.14b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Spirax-Sarco Engineering's net debt is only 0.36 times its EBITDA. And its EBIT easily covers its interest expense, being 62.3 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In addition to that, we're happy to report that Spirax-Sarco Engineering has boosted its EBIT by 31%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Spirax-Sarco Engineering can strengthen its balance sheet over time. 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. During the last three years, Spirax-Sarco Engineering produced sturdy free cash flow equating to 72% 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
Spirax-Sarco Engineering's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its EBIT growth rate also supports that impression! We think Spirax-Sarco Engineering is no more beholden to its lenders, than the birds are to birdwatchers. To our minds it has a healthy happy balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Spirax-Sarco Engineering that you should be aware of before investing here.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.
About LSE:SPX
Spirax Group
Spirax Group PLC provides thermal energy and fluid technology solutions.
Established dividend payer with mediocre balance sheet.
