Is AZZ (NYSE:AZZ) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that AZZ Inc. (NYSE:AZZ) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for AZZ

How Much Debt Does AZZ Carry?

As you can see below, AZZ had US$929.8m of debt at May 2024, down from US$1.04b a year prior. Net debt is about the same, since the it doesn't have much cash.

A Look At AZZ's Liabilities

The latest balance sheet data shows that AZZ had liabilities of US$223.9m due within a year, and liabilities of US$1.04b falling due after that. On the other hand, it had cash of US$10.5m and US$255.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.00b.

While this might seem like a lot, it is not so bad since AZZ has a market capitalization of US$2.45b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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.

While AZZ's debt to EBITDA ratio (2.9) suggests that it uses some debt, its interest cover is very weak, at 2.3, suggesting high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Fortunately, AZZ grew its EBIT by 2.1% in the last year, slowly shrinking its debt relative to earnings. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine AZZ'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, AZZ's free cash flow amounted to 49% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

AZZ's interest cover was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. But on the bright side, its ability to to convert EBIT to free cash flow isn't too shabby at all. Looking at all the angles mentioned above, it does seem to us that AZZ is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 4 warning signs we've spotted with AZZ (including 1 which is concerning) .

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com