Some say volatility, rather than debt, is the best way to view 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. We notice that Edgewell Personal Care Company (NYSE: EPC) has debt on its balance sheet. But should shareholders be worried about its use of debt?
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. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. 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. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business 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 flow and debt together.
What is Edgewell Personal Care’s debt?
The image below, which you can click for more details, shows that in March 2021, Edgewell Personal Care was in debt of $ 1.26 billion, up from $ 1.12 billion in a year. . On the other hand, it has $ 282.1 million in cash, resulting in net debt of around $ 975.1 million.
NYSE: Historical EPC Debt to Equity May 21, 2021
How healthy is Edgewell Personal Care’s track record?
The latest balance sheet data shows that Edgewell Personal Care had liabilities of US $ 483.8 million due within one year and liabilities of US $ 1.59 billion due thereafter. In compensation for these obligations, it had cash of US $ 282.1 million as well as receivables valued at US $ 268.3 million at 12 months. It therefore has liabilities totaling US $ 1.52 billion more than its cash and short-term receivables combined.
This is a mountain of leverage compared to its market cap of US $ 2.43 billion. If its lenders asked it to consolidate the balance sheet, shareholders would likely face severe dilution.
We use two main ratios to tell us about leverage versus earnings levels. 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). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Edgewell Personal Care has a debt to EBITDA ratio of 3.1 and its EBIT has covered its interest expense 3.5 times. Overall, this implies that while we wouldn’t like to see debt levels rise, we believe it can handle its current leverage. Worse yet, Edgewell Personal Care’s EBIT was 25% lower than last year. If the income continues like this for the long haul, there is an incredible chance to pay off that debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future profits, more than anything, that will determine Edgewell Personal Care’s ability to maintain a healthy balance sheet in the future. So if you want to see what the pros think about it, you might find this free report on analysts’ earnings forecasts Be interesting.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Edgewell Personal Care has generated strong free cash flow equivalent to 51% of its EBIT, roughly what we expected. This hard cash allows him to reduce his debt whenever he wants.
Our point of view
Reflecting on Edgewell Personal Care’s attempt to (not) increase its EBIT, we are certainly not enthusiastic. That said, its ability to convert EBIT into free cash flow is not that much of a concern. Looking at the big picture, it seems clear to us that Edgewell Personal Care’s use of debt creates risks for the business. If all goes well it may pay off, but the downside to this debt is a greater risk of permanent losses. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. Example: we have spotted 4 warning signs for Edgewell Personal Care you need to be aware of it, and one of them is of concern.
If you are interested in investing in companies that can generate profits without the burden of debt, check out this page free list of growing companies that have net cash on the balance sheet.
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