Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Like many other companies Advanced Energy Industries, Inc. (NASDAQ:AEIS) uses debt. But the real question is whether this debt makes the business risky.
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, debt can be an important tool in businesses, especially capital-intensive 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 Advanced Energy Industries
How much debt does Advanced Energy Industries have?
You can click on the graph below for historical numbers, but it shows that in June 2022, Advanced Energy Industries had debt of $383.0 million, up from $313.7 million, over a year. However, he also had $372.7 million in cash, so his net debt is $10.3 million.
How healthy is Advanced Energy Industries’ balance sheet?
The latest balance sheet data shows that Advanced Energy Industries had liabilities of $389.0 million due within the year, and liabilities of $564.2 million due thereafter. On the other hand, it had $372.7 million in cash and $270.8 million in receivables within one year. Thus, its liabilities outweigh the sum of its cash and receivables (current) by $309.7 million.
Given that publicly traded shares of Advanced Energy Industries are worth a total of US$3.11 billion, it seems unlikely that this level of liability is a major threat. However, we think it’s worth keeping an eye on the strength of its balance sheet, as it can change over time. Either way, Advanced Energy Industries has virtually no net debt, so it’s fair to say it’s not heavily leveraged!
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
With debt at a measly 0.044 times EBITDA and EBIT covering interest at 32.2 times, it’s clear that Advanced Energy Industries is not a desperate borrower. Thus, compared to previous income, the level of indebtedness seems insignificant. In contrast, Advanced Energy Industries’ EBIT fell 18% over the past year. If this rate of decline in profits continues, the company could find itself in a delicate situation. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Advanced Energy Industries’ ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Advanced Energy Industries has recorded free cash flow of 61% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
Fortunately, Advanced Energy Industries’ impressive interest coverage means it has the upper hand on its debt. But we have to admit that we are seeing its EBIT growth rate having the opposite effect. Looking at all of the aforementioned factors together, it seems to us that Advanced Energy Industries can manage its debt quite comfortably. Of course, while this leverage can improve return on equity, it comes with more risk, so it’s worth keeping an eye out for. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. Example: we have identified 1 warning sign for Advanced Energy Industries you should be aware.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
Valuation is complex, but we help make it simple.
Find out if Advanced Energy Industries is potentially overvalued or undervalued by viewing our full analysis, which includes fair value estimates, risks and warnings, dividends, insider trading and financial health.
See the free analysis