These 4 Measures Indicate That Alamo Group (NYSE:ALG) Is Using Debt Reasonably Well

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. We note that Alamo Group Inc. (NYSE:ALG) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Alamo Group

What Is Alamo Group's Debt?

The image below, which you can click on for greater detail, shows that Alamo Group had debt of US$321.5m at the end of March 2024, a reduction from US$371.2m over a year. On the flip side, it has US$121.8m in cash leading to net debt of about US$199.7m.

How Healthy Is Alamo Group's Balance Sheet?

According to the last reported balance sheet, Alamo Group had liabilities of US$213.4m due within 12 months, and liabilities of US$349.5m due beyond 12 months. Offsetting these obligations, it had cash of US$121.8m as well as receivables valued at US$393.0m due within 12 months. So it has liabilities totalling US$48.0m more than its cash and near-term receivables, combined.

Given Alamo Group has a market capitalization of US$2.11b, 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.

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).

Alamo Group has net debt of just 0.81 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 8.0 times, which is more than adequate. And we also note warmly that Alamo Group grew its EBIT by 16% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Alamo Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Alamo Group's free cash flow amounted to 22% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Happily, Alamo Group's impressive net debt to EBITDA implies it has the upper hand on its debt. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. All these things considered, it appears that Alamo Group can comfortably handle its current debt levels. 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. 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 Alamo Group that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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