Does Enerpac Tool Group (NYSE:EPAC) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Enerpac Tool Group Corp. (NYSE:EPAC) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 Enerpac Tool Group

What Is Enerpac Tool Group's Debt?

The image below, which you can click on for greater detail, shows that at May 2023 Enerpac Tool Group had debt of US$234.7m, up from US$205.0m in one year. On the flip side, it has US$142.0m in cash leading to net debt of about US$92.7m.

A Look At Enerpac Tool Group's Liabilities

According to the last reported balance sheet, Enerpac Tool Group had liabilities of US$140.2m due within 12 months, and liabilities of US$316.2m due beyond 12 months. On the other hand, it had cash of US$142.0m and US$106.6m worth of receivables due within a year. So its liabilities total US$207.9m more than the combination of its cash and short-term receivables.

Since publicly traded Enerpac Tool Group shares are worth a total of US$1.48b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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).

Enerpac Tool Group's net debt is only 0.72 times its EBITDA. And its EBIT easily covers its interest expense, being 10.9 times the size. So we're pretty relaxed about its super-conservative use of debt. Better yet, Enerpac Tool Group grew its EBIT by 144% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Enerpac Tool Group's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Enerpac Tool Group produced sturdy free cash flow equating to 57% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, Enerpac Tool Group's impressive EBIT growth rate implies it has the upper hand on its debt. And that's just the beginning of the good news since its interest cover is also very heartening. Looking at the bigger picture, we think Enerpac Tool Group's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Enerpac Tool Group that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.