We Think ESCO Technologies (NYSE:ESE) 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.' 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, ESCO Technologies Inc. (NYSE:ESE) does carry debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
View our latest analysis for ESCO Technologies
What Is ESCO Technologies's Net Debt?
You can click the graphic below for the historical numbers, but it shows that ESCO Technologies had US$55.8m of debt in December 2020, down from US$150.9m, one year before. But on the other hand it also has US$57.4m in cash, leading to a US$1.52m net cash position.
A Look At ESCO Technologies' Liabilities
The latest balance sheet data shows that ESCO Technologies had liabilities of US$254.6m due within a year, and liabilities of US$149.4m falling due after that. On the other hand, it had cash of US$57.4m and US$237.4m worth of receivables due within a year. So it has liabilities totalling US$109.2m more than its cash and near-term receivables, combined.
Given ESCO Technologies has a market capitalization of US$2.74b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, ESCO Technologies also has more cash than debt, so we're pretty confident it can manage its debt safely.
On the other hand, ESCO Technologies's EBIT dived 10%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine ESCO Technologies's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While ESCO Technologies has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, ESCO Technologies produced sturdy free cash flow equating to 60% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing up
We could understand if investors are concerned about ESCO Technologies's liabilities, but we can be reassured by the fact it has has net cash of US$1.52m. So we are not troubled with ESCO Technologies's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with ESCO Technologies , and understanding them should be part of your investment process.
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.
This article by Simply Wall St is general in nature. 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.
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