David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We note that EVI Industries, Inc. (NYSEMKT:EVI) does have debt on its balance sheet. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is EVI Industries's Net Debt?
The image below, which you can click on for greater detail, shows that at March 2019 EVI Industries had debt of US$41.6m, up from US$22.2m in one year. On the flip side, it has US$6.73m in cash leading to net debt of about US$34.8m.
A Look At EVI Industries's Liabilities
According to the last reported balance sheet, EVI Industries had liabilities of US$32.4m due within 12 months, and liabilities of US$46.9m due beyond 12 months. Offsetting these obligations, it had cash of US$6.73m as well as receivables valued at US$30.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$42.5m.
Of course, EVI Industries has a market capitalization of US$377.9m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
EVI Industries's debt is 3.7 times its EBITDA, and its EBIT cover its interest expense 6.3 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. EVI Industries grew its EBIT by 7.2% in the last year. That's far from incredible but it is a good thing, when it comes to paying off debt. There's no doubt that we learn most about debt from the balance sheet. But it is EVI Industries's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, EVI Industries created free cash flow amounting to 13% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
EVI Industries's conversion of EBIT to free cash flow was a real negative on this analysis, as was its net debt to EBITDA. On the other hand, we found comfort in its relatively strong EBIT growth rate. Looking at all this data makes us feel a little cautious about EVI Industries's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. We'd be motivated to research the stock further if we found out that EVI Industries insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
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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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.