We Think Eagle Materials (NYSE:EXP) Can Stay On Top Of Its 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. Importantly, Eagle Materials Inc. (NYSE:EXP) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Eagle Materials

How Much Debt Does Eagle Materials Carry?

As you can see below, at the end of December 2022, Eagle Materials had US$1.06b of debt, up from US$837.9m a year ago. Click the image for more detail. On the flip side, it has US$60.9m in cash leading to net debt of about US$1.00b.

How Healthy Is Eagle Materials' Balance Sheet?

The latest balance sheet data shows that Eagle Materials had liabilities of US$208.3m due within a year, and liabilities of US$1.36b falling due after that. On the other hand, it had cash of US$60.9m and US$178.0m worth of receivables due within a year. So it has liabilities totalling US$1.33b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Eagle Materials has a market capitalization of US$4.96b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Eagle Materials's net debt is only 1.5 times its EBITDA. And its EBIT covers its interest expense a whopping 19.3 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Another good sign is that Eagle Materials has been able to increase its EBIT by 23% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Eagle Materials 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, 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, Eagle Materials 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

The good news is that Eagle Materials's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Looking at the bigger picture, we think Eagle Materials'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. 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 - Eagle Materials has 2 warning signs we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.