Is Evoqua Water Technologies (NYSE:AQUA) Using Too Much Debt?

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.' 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. Importantly, Evoqua Water Technologies Corp. (NYSE:AQUA) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Evoqua Water Technologies

What Is Evoqua Water Technologies's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2022 Evoqua Water Technologies had US$871.8m of debt, an increase on US$730.4m, over one year. However, it also had US$127.0m in cash, and so its net debt is US$744.8m.

How Strong Is Evoqua Water Technologies' Balance Sheet?

According to the last reported balance sheet, Evoqua Water Technologies had liabilities of US$486.8m due within 12 months, and liabilities of US$990.8m due beyond 12 months. Offsetting these obligations, it had cash of US$127.0m as well as receivables valued at US$420.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$930.6m.

Since publicly traded Evoqua Water Technologies shares are worth a total of US$5.95b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Evoqua Water Technologies's debt is 2.9 times its EBITDA, and its EBIT cover its interest expense 3.3 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. However, one redeeming factor is that Evoqua Water Technologies grew its EBIT at 19% over the last 12 months, boosting its ability to handle its debt. 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 Evoqua Water Technologies'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 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. Over the most recent three years, Evoqua Water Technologies recorded free cash flow worth 74% 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

Happily, Evoqua Water Technologies'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 Evoqua Water Technologies can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. Be aware that Evoqua Water Technologies is showing 1 warning sign in our investment analysis , you should know about...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's 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.