These 4 Measures Indicate That Carpenter Technology (NYSE:CRS) Is Using Debt Extensively

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Carpenter Technology Corporation (NYSE:CRS) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Carpenter Technology

What Is Carpenter Technology's Net Debt?

The chart below, which you can click on for greater detail, shows that Carpenter Technology had US$693.0m in debt in June 2023; about the same as the year before. However, it also had US$44.5m in cash, and so its net debt is US$648.5m.

A Look At Carpenter Technology's Liabilities

The latest balance sheet data shows that Carpenter Technology had liabilities of US$459.4m due within a year, and liabilities of US$1.20b falling due after that. Offsetting this, it had US$44.5m in cash and US$531.3m in receivables that were due within 12 months. So its liabilities total US$1.08b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Carpenter Technology is worth US$3.17b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Carpenter Technology's debt to EBITDA ratio (2.7) suggests that it uses some debt, its interest cover is very weak, at 2.3, suggesting high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. One redeeming factor for Carpenter Technology is that it turned last year's EBIT loss into a gain of US$123m, over the last twelve months. 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 Carpenter Technology'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, 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. Over the last year, Carpenter Technology saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

We'd go so far as to say Carpenter Technology's conversion of EBIT to free cash flow was disappointing. Having said that, its ability to grow its EBIT isn't such a worry. Overall, we think it's fair to say that Carpenter Technology has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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. For example Carpenter Technology has 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.