We Think Atmus Filtration Technologies (NYSE:ATMU) Can Stay On Top Of Its 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.' 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. As with many other companies Atmus Filtration Technologies Inc. (NYSE:ATMU) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

Check out our latest analysis for Atmus Filtration Technologies

How Much Debt Does Atmus Filtration Technologies Carry?

You can click the graphic below for the historical numbers, but it shows that Atmus Filtration Technologies had US$600.0m of debt in June 2024, down from US$650.0m, one year before. However, because it has a cash reserve of US$160.5m, its net debt is less, at about US$439.5m.

A Look At Atmus Filtration Technologies' Liabilities

We can see from the most recent balance sheet that Atmus Filtration Technologies had liabilities of US$365.1m falling due within a year, and liabilities of US$634.1m due beyond that. Offsetting these obligations, it had cash of US$160.5m as well as receivables valued at US$275.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$562.9m.

Since publicly traded Atmus Filtration Technologies shares are worth a total of US$2.83b, 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.

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). 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).

Atmus Filtration Technologies's net debt is sitting at a very reasonable 1.5 times its EBITDA, while its EBIT covered its interest expense just 6.1 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Another good sign is that Atmus Filtration Technologies has been able to increase its EBIT by 26% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Atmus Filtration 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 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, Atmus Filtration Technologies recorded free cash flow worth 57% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, Atmus Filtration Technologies's impressive EBIT growth rate implies it has the upper hand on its debt. And its conversion of EBIT to free cash flow is good too. When we consider the range of factors above, it looks like Atmus Filtration Technologies is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Atmus Filtration Technologies you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.