These 4 Measures Indicate That ESCO Technologies (NYSE:ESE) Is Using Debt Safely

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that ESCO Technologies Inc. (NYSE:ESE) 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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 ESCO Technologies

How Much Debt Does ESCO Technologies Carry?

The image below, which you can click on for greater detail, shows that ESCO Technologies had debt of US$102.0m at the end of September 2023, a reduction from US$153.0m over a year. However, it also had US$41.9m in cash, and so its net debt is US$60.1m.

How Strong Is ESCO Technologies' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that ESCO Technologies had liabilities of US$314.7m due within 12 months and liabilities of US$237.4m due beyond that. Offsetting this, it had US$41.9m in cash and US$337.2m in receivables that were due within 12 months. So its liabilities total US$173.0m more than the combination of its cash and short-term receivables.

Of course, ESCO Technologies has a market capitalization of US$2.97b, so these liabilities are probably manageable. 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

ESCO Technologies's net debt is only 0.33 times its EBITDA. And its EBIT covers its interest expense a whopping 14.8 times over. So we're pretty relaxed about its super-conservative use of debt. And we also note warmly that ESCO Technologies grew its EBIT by 17% last year, making its debt load easier to handle. 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 ESCO Technologies's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, ESCO Technologies produced sturdy free cash flow equating to 68% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, ESCO Technologies's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its net debt to EBITDA is also very heartening. Zooming out, ESCO Technologies seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. Over time, share prices tend to follow earnings per share, so if you're interested in ESCO Technologies, you may well want to click here to check an interactive graph of its earnings per share history.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.