Is Enerpac Tool Group (NYSE:EPAC) 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.' 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. Importantly, Enerpac Tool Group Corp. (NYSE:EPAC) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Enerpac Tool Group

What Is Enerpac Tool Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Enerpac Tool Group had US$175.0m of debt in February 2022, down from US$210.0m, one year before. On the flip side, it has US$133.4m in cash leading to net debt of about US$41.6m.

A Look At Enerpac Tool Group's Liabilities

We can see from the most recent balance sheet that Enerpac Tool Group had liabilities of US$140.3m falling due within a year, and liabilities of US$268.1m due beyond that. On the other hand, it had cash of US$133.4m and US$116.4m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$158.6m.

Since publicly traded Enerpac Tool Group shares are worth a total of US$1.26b, 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 use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Enerpac Tool Group has a low net debt to EBITDA ratio of only 0.49. And its EBIT easily covers its interest expense, being 23.8 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Better yet, Enerpac Tool Group grew its EBIT by 233% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. 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 Enerpac Tool Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Enerpac Tool Group recorded free cash flow worth a fulsome 83% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

The good news is that Enerpac Tool Group's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! It looks Enerpac Tool Group has no trouble standing on its own two feet, and it has no reason to fear its lenders. To our minds it has a healthy happy balance sheet. 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. To that end, you should be aware of the 2 warning signs we've spotted with Enerpac Tool Group .

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.