Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. As with many other companies Aegion Corporation (NASDAQ:AEGN) makes use of debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Aegion Carry?
The image below, which you can click on for greater detail, shows that Aegion had debt of US$270.6m at the end of June 2020, a reduction from US$309.5m over a year. However, it does have US$95.3m in cash offsetting this, leading to net debt of about US$175.2m.
A Look At Aegion's Liabilities
Zooming in on the latest balance sheet data, we can see that Aegion had liabilities of US$213.2m due within 12 months and liabilities of US$323.4m due beyond that. Offsetting these obligations, it had cash of US$95.3m as well as receivables valued at US$244.7m due within 12 months. So its liabilities total US$196.5m more than the combination of its cash and short-term receivables.
Aegion has a market capitalization of US$460.0m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.
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.
Aegion's net debt is sitting at a very reasonable 1.8 times its EBITDA, while its EBIT covered its interest expense just 4.3 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Aegion grew its EBIT by 5.2% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Aegion 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Aegion generated free cash flow amounting to a very robust 88% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
On our analysis Aegion's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to cover its interest expense with its EBIT. Considering this range of data points, we think Aegion is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Aegion that you should be aware of.
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. 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.
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