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 can see that EMCOR Group, Inc. (NYSE:EME) does use debt in its business. But is this debt a concern to shareholders?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does EMCOR Group Carry?
The image below, which you can click on for greater detail, shows that EMCOR Group had debt of US$266.6m at the end of December 2020, a reduction from US$302.6m over a year. However, it does have US$902.9m in cash offsetting this, leading to net cash of US$636.3m.
How Strong Is EMCOR Group's Balance Sheet?
According to the last reported balance sheet, EMCOR Group had liabilities of US$2.16b due within 12 months, and liabilities of US$847.4m due beyond 12 months. On the other hand, it had cash of US$902.9m and US$2.11b worth of receivables due within a year. So these liquid assets roughly match the total liabilities.
Having regard to EMCOR Group's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$6.14b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that EMCOR Group has more cash than debt is arguably a good indication that it can manage its debt safely.
The good news is that EMCOR Group has increased its EBIT by 6.6% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if EMCOR Group 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 company can only pay off debt with cold hard cash, not accounting profits. EMCOR Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, EMCOR Group generated free cash flow amounting to a very robust 95% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
While we empathize with investors who find debt concerning, you should keep in mind that EMCOR Group has net cash of US$636.3m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$758m, being 95% of its EBIT. So is EMCOR Group's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - EMCOR Group has 3 warning signs we think you should be aware of.
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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