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

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that ESCO Technologies Inc. (NYSE:ESE) does use debt in its business. But is this debt a concern to shareholders?

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When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is ESCO Technologies's Net Debt?

You can click the graphic below for the historical numbers, but it shows that ESCO Technologies had US$112.0m of debt in December 2024, down from US$172.0m, one year before. On the flip side, it has US$71.3m in cash leading to net debt of about US$40.7m.

How Strong Is ESCO Technologies' Balance Sheet?

According to the last reported balance sheet, ESCO Technologies had liabilities of US$316.1m due within 12 months, and liabilities of US$242.0m due beyond 12 months. On the other hand, it had cash of US$71.3m and US$334.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$152.8m.

Given ESCO Technologies has a market capitalization of US$4.25b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Carrying virtually no net debt, ESCO Technologies has a very light debt load indeed.

Check out our latest analysis for ESCO Technologies

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 has a low net debt to EBITDA ratio of only 0.19. And its EBIT easily covers its interest expense, being 10.5 times the size. So we're pretty relaxed about its super-conservative use of debt. And we also note warmly that ESCO Technologies grew its EBIT by 19% 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 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, ESCO Technologies recorded free cash flow worth 62% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, ESCO Technologies's impressive net debt to EBITDA implies it has the upper hand on its debt. And the good news does not stop there, as its interest cover also supports that impression! Looking at the bigger picture, we think ESCO Technologies's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. We'd be very excited to see if ESCO Technologies insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.

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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.