Is Energy Services of America (NASDAQ:ESOA) Using Too Much Debt?

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 Energy Services of America Corporation (NASDAQ:ESOA) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Energy Services of America

How Much Debt Does Energy Services of America Carry?

The image below, which you can click on for greater detail, shows that at September 2022 Energy Services of America had debt of US$30.6m, up from US$17.5m in one year. However, it also had US$7.43m in cash, and so its net debt is US$23.2m.

A Look At Energy Services of America's Liabilities

According to the last reported balance sheet, Energy Services of America had liabilities of US$55.3m due within 12 months, and liabilities of US$19.0m due beyond 12 months. On the other hand, it had cash of US$7.43m and US$59.0m worth of receivables due within a year. So it has liabilities totalling US$7.86m more than its cash and near-term receivables, combined.

Of course, Energy Services of America has a market capitalization of US$46.2m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Energy Services of America's net debt of 1.9 times EBITDA suggests graceful use of debt. And the fact that its trailing twelve months of EBIT was 7.3 times its interest expenses harmonizes with that theme. We also note that Energy Services of America improved its EBIT from a last year's loss to a positive US$6.5m. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Energy Services of America 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Looking at the most recent year, Energy Services of America recorded free cash flow of 46% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Energy Services of America's interest cover was a real positive on this analysis, as was its level of total liabilities. On the other hand, its EBIT growth rate makes us a little less comfortable about its debt. Considering this range of data points, we think Energy Services of America is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 5 warning signs for Energy Services of America you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.