Here's Why Altra Industrial Motion (NASDAQ:AIMC) Can Manage Its Debt Responsibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Altra Industrial Motion Corp. (NASDAQ:AIMC) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 Altra Industrial Motion

What Is Altra Industrial Motion's Debt?

You can click the graphic below for the historical numbers, but it shows that Altra Industrial Motion had US$1.38b of debt in June 2021, down from US$1.55b, one year before. On the flip side, it has US$277.8m in cash leading to net debt of about US$1.10b.

A Look At Altra Industrial Motion's Liabilities

The latest balance sheet data shows that Altra Industrial Motion had liabilities of US$362.4m due within a year, and liabilities of US$1.79b falling due after that. On the other hand, it had cash of US$277.8m and US$274.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.60b.

Altra Industrial Motion has a market capitalization of US$3.56b, 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Altra Industrial Motion's debt is 2.9 times its EBITDA, and its EBIT cover its interest expense 3.8 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. On a lighter note, we note that Altra Industrial Motion grew its EBIT by 22% in the last year. If sustained, this growth should make that debt evaporate like a scarce drinking water during an unnaturally hot summer. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Altra Industrial Motion'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Altra Industrial Motion recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

Happily, Altra Industrial Motion's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its interest cover. Looking at all the aforementioned factors together, it strikes us that Altra Industrial Motion can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. To that end, you should be aware of the 1 warning sign we've spotted with Altra Industrial Motion .

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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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.
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