Is Applied Industrial Technologies (NYSE:AIT) Using Too Much Debt?

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.' 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. We can see that Applied Industrial Technologies, Inc. (NYSE:AIT) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Applied Industrial Technologies

What Is Applied Industrial Technologies's Debt?

The image below, which you can click on for greater detail, shows that Applied Industrial Technologies had debt of US$649.2m at the end of December 2022, a reduction from US$721.4m over a year. However, it does have US$165.5m in cash offsetting this, leading to net debt of about US$483.7m.

How Healthy Is Applied Industrial Technologies' Balance Sheet?

According to the last reported balance sheet, Applied Industrial Technologies had liabilities of US$447.2m due within 12 months, and liabilities of US$779.8m due beyond 12 months. Offsetting these obligations, it had cash of US$165.5m as well as receivables valued at US$670.1m due within 12 months. So its liabilities total US$391.4m more than the combination of its cash and short-term receivables.

Given Applied Industrial Technologies has a market capitalization of US$5.36b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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.

Applied Industrial Technologies's net debt is only 1.0 times its EBITDA. And its EBIT easily covers its interest expense, being 17.2 times the size. So we're pretty relaxed about its super-conservative use of debt. On top of that, Applied Industrial Technologies grew its EBIT by 37% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Applied Industrial Technologies'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Applied Industrial Technologies produced sturdy free cash flow equating to 70% 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

The good news is that Applied Industrial Technologies's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its EBIT growth rate also supports that impression! Considering this range of factors, it seems to us that Applied Industrial Technologies is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, to us. Another factor that would give us confidence in Applied Industrial Technologies would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly 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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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.