Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from risk.” So it can be obvious that you need to consider debt, when you think about how risky a given stock is because too much debt can sink a business. Above all, Eastman Chemical Company (NYSE: EMN) is in debt. But the most important question is: what risk does this debt create?
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. When we think of a business’s use of debt, we first look at cash flow and debt together.
Check out our latest review for Eastman Chemical
What is Eastman Chemical’s debt?
You can click on the graph below for the historical figures, but it shows Eastman Chemical was in debt of US $ 5.57 billion in June 2021, down from US $ 6.13 billion a year earlier. However, it has $ 610.0 million in cash offsetting that, leading to net debt of around $ 4.96 billion.
How healthy is Eastman Chemical’s balance sheet?
We can see from the most recent balance sheet that Eastman Chemical had liabilities of US $ 2.30 billion maturing within one year and liabilities of US $ 7.78 billion maturing within one year. of the. In compensation for these obligations, he had cash of US $ 610.0 million as well as receivables valued at US $ 1.74 billion due within 12 months. Its liabilities therefore total $ 7.72 billion more than the combination of its cash and short-term receivables.
This deficit is not that big as Eastman Chemical is worth US $ 13.9 billion and could therefore probably raise enough capital to consolidate its balance sheet, should the need arise. However, it is always worth taking a close look at your ability to repay your debt.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). Thus, we consider debt versus earnings with and without amortization charges.
Eastman Chemical has a debt to EBITDA ratio of 2.7 and its EBIT covered its interest expense 6.1 times. This suggests that while debt levels are significant, we would stop calling them problematic. If Eastman Chemical can continue to grow its EBIT at last year’s rate of 15% over last year, then its debt will be more manageable. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future profits, more than anything, that will determine Eastman Chemical’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business needs free cash flow to repay its debts; accounting profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Eastman Chemical has generated free cash flow of a very strong 92% of EBIT, more than we expected. This puts him in a very strong position to pay off the debt.
Our point of view
Fortunately, Eastman Chemical’s impressive conversion of EBIT to free cash flow means it has the upper hand over its debt. But frankly, we think his total passive level undermines that feeling a bit. All these things considered, it looks like Eastman Chemical can comfortably manage its current debt levels. On the plus side, this leverage can increase returns to shareholders, but the potential downside is more risk of loss, so it’s worth watching the balance sheet. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. To do this, you need to know the 5 warning signs we spotted with Eastman Chemical.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
Do you have any feedback on this item? Are you worried about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.
If you are looking to trade Eastman Chemical, open an account with the cheapest * professionally approved platform, Interactive brokers. Their clients from more than 200 countries and territories trade stocks, options, futures, currencies, bonds and funds around the world from a single integrated account.Promoted