Does A. O. Smith (NYSE:AOS) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that A. O. Smith Corporation (NYSE:AOS) does use debt in its business. But is this debt a concern to shareholders?

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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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does A. O. Smith Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2025 A. O. Smith had US$270.6m of debt, an increase on US$119.7m, over one year. On the flip side, it has US$200.2m in cash leading to net debt of about US$70.4m.

How Healthy Is A. O. Smith's Balance Sheet?

According to the last reported balance sheet, A. O. Smith had liabilities of US$882.1m due within 12 months, and liabilities of US$530.5m due beyond 12 months. Offsetting these obligations, it had cash of US$200.2m as well as receivables valued at US$641.5m due within 12 months. So its liabilities total US$570.9m more than the combination of its cash and short-term receivables.

Of course, A. O. Smith has a market capitalization of US$9.19b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. But either way, A. O. Smith has virtually no net debt, so it's fair to say it does not have a heavy debt load!

See our latest analysis for A. O. Smith

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With debt at a measly 0.092 times EBITDA and EBIT covering interest a whopping 80.1 times, it's clear that A. O. Smith is not a desperate borrower. Indeed relative to its earnings its debt load seems light as a feather. But the other side of the story is that A. O. Smith saw its EBIT decline by 7.7% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 A. O. Smith 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, A. O. Smith recorded free cash flow worth 67% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that A. O. Smith's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its EBIT growth rate does undermine this impression a bit. Taking all this data into account, it seems to us that A. O. Smith takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. We'd be motivated to research the stock further if we found out that A. O. Smith insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

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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.