Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Like many other companies AMETEK, Inc. (NYSE:AME) uses debt. But does this debt worry shareholders?
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. 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 step when considering a company’s debt levels is to consider its cash and debt together.
See our latest review for AMETEK
What is AMETEK’s net debt?
You can click on the graph below for historical numbers, but it shows AMETEK had $2.50 billion in debt in June 2022, up from $2.96 billion a year prior. However, since he has a cash reserve of $348.7 million, his net debt is less, at around $2.15 billion.
A Look at AMETEK’s Responsibilities
According to the last published balance sheet, AMETEK had liabilities of US$1.63 billion due within 12 months and liabilities of US$3.40 billion due beyond 12 months. As compensation for these obligations, it had cash of US$348.7 million and receivables valued at US$993.0 million due within 12 months. It therefore has liabilities totaling $3.69 billion more than its cash and short-term receivables, combined.
Of course, AMETEK has a titanic market capitalization of US$29.0 billion, so those liabilities are probably manageable. But there are enough liabilities that we certainly recommend that shareholders continue to monitor the balance sheet in the future.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
AMETEK’s net debt represents only 1.2 times its EBITDA. And its EBIT easily covers its interest charges, which is 17.9 times the size. So we’re pretty relaxed about his super-conservative use of debt. Another good thing is that AMETEK has increased its EBIT by 20% over the past year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine AMETEK’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, a company can only repay its debts with cold hard cash, not with book profits. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, AMETEK has generated free cash flow of a very strong 89% of EBIT, more than we expected. This puts him in a very strong position to pay off the debt.
Our point of view
The good news is that AMETEK’s demonstrated ability to cover its interest costs with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, since its conversion of EBIT into free cash flow also confirms this impression! Zooming out, AMETEK seems to be using debt quite sensibly; and that gets the green light from us. Although debt carries risks, when used wisely, it can also generate a higher return on equity. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. We have identified 1 warning sign with AMETEK, and understanding them should be part of your investment process.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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