Here's Why Ecovyst (NYSE:ECVT) Can Manage Its Debt Responsibly

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.' 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. Importantly, Ecovyst Inc. (NYSE:ECVT) 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Ecovyst

How Much Debt Does Ecovyst Carry?

The chart below, which you can click on for greater detail, shows that Ecovyst had US$872.6m in debt in June 2023; about the same as the year before. On the flip side, it has US$63.9m in cash leading to net debt of about US$808.7m.

A Look At Ecovyst's Liabilities

According to the last reported balance sheet, Ecovyst had liabilities of US$103.0m due within 12 months, and liabilities of US$1.04b due beyond 12 months. Offsetting these obligations, it had cash of US$63.9m as well as receivables valued at US$78.2m due within 12 months. So it has liabilities totalling US$1.00b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of US$1.14b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While Ecovyst's debt to EBITDA ratio (4.1) suggests that it uses some debt, its interest cover is very weak, at 2.2, suggesting high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. On a slightly more positive note, Ecovyst grew its EBIT at 19% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Ecovyst'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, Ecovyst actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

When it comes to the balance sheet, the standout positive for Ecovyst was the fact that it seems able to convert EBIT to free cash flow confidently. But the other factors we noted above weren't so encouraging. In particular, interest cover gives us cold feet. When we consider all the factors mentioned above, we do feel a bit cautious about Ecovyst's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Ecovyst has 1 warning sign we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.