Is Ecosuntek (BIT:ECK) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Ecosuntek S.p.A. (BIT:ECK) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Ecosuntek

How Much Debt Does Ecosuntek Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Ecosuntek had debt of €79.0m, up from €41.1m in one year. However, because it has a cash reserve of €62.1m, its net debt is less, at about €16.9m.

A Look At Ecosuntek's Liabilities

According to the last reported balance sheet, Ecosuntek had liabilities of €132.1m due within 12 months, and liabilities of €62.3m due beyond 12 months. Offsetting this, it had €62.1m in cash and €82.8m in receivables that were due within 12 months. So its liabilities total €49.4m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the €30.8m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Ecosuntek would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Looking at its net debt to EBITDA of 1.2 and interest cover of 2.5 times, it seems to us that Ecosuntek is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Unfortunately, Ecosuntek's EBIT flopped 17% over the last four quarters. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. When analysing debt levels, the balance sheet is the obvious place to start. But it is Ecosuntek's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Ecosuntek's free cash flow amounted to 37% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

To be frank both Ecosuntek's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at managing its debt, based on its EBITDA,; that's encouraging. After considering the datapoints discussed, we think Ecosuntek has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Ecosuntek is showing 5 warning signs in our investment analysis , and 2 of those are significant...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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

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.