Legendary fund manager Li Lu (whom Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Like many other companies Eagle Materials Inc. (NYSE: EXP) uses debt. But the real question is whether this debt makes the business risky.
What risk does debt entail?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. 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 Eagle Materials
What is the debt of Eagle Materials?
The image below, which you can click for more details, shows Eagle Materials owed $ 1.01 billion in debt at the end of June 2021, a reduction from $ 1.49 billion. US over one year. However, given that it has a cash reserve of $ 306.5 million, its net debt is less, at around $ 702.5 million.
How healthy is Eagle Materials’ balance sheet?
The latest balance sheet data shows that Eagle Materials had liabilities of US $ 189.0 million due within one year, and liabilities of US $ 1.31 billion due thereafter. In return, he had $ 306.5 million in cash and $ 187.4 million in receivables due within 12 months. Its liabilities therefore total US $ 1.01 billion more than the combination of its cash and short-term receivables.
Of course, Eagle Materials has a market cap of US $ 5.78 billion, so this liability is likely manageable. Having said that, it is clear that we must continue to monitor his record lest it get worse.
We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
Eagle Materials has a low net debt to EBITDA ratio of just 1.3. And its EBIT covers its interest costs a whopping 11.6 times more. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Another good sign is that Eagle Materials was able to increase its EBIT by 23% in twelve months, making it easier to repay debt. The balance sheet is clearly the area you need to focus on when analyzing debt. But it is future profits, more than anything, that will determine Eagle Materials’ ability to maintain a healthy balance sheet going forward. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business can only pay off its debts with hard cash, not with book profits. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, Eagle Materials has actually generated more free cash flow than EBIT. There is nothing better than cash flow to stay in the good graces of your lenders.
Our point of view
The good news is that Eagle Materials’ demonstrated ability to convert EBIT into free cash flow delights us like a fluffy puppy does a toddler. And that’s just the start of the good news since its coverage of interest is also very encouraging. Looking at the big picture, we think Eagle Materials’ use of debt looks very reasonable and we don’t care. After all, reasonable leverage can increase returns on equity. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. To do this, you need to know the 2 warning signs we spotted with Eagle Materials.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash net growth stocks.
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 any of the stocks mentioned.
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