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.' 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 Ashland Inc. (NYSE:ASH) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Ashland Carry?
As you can see below, Ashland had US$1.33b of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has US$439.0m in cash leading to net debt of about US$889.0m.
How Strong Is Ashland's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Ashland had liabilities of US$453.0m due within 12 months and liabilities of US$2.36b due beyond that. On the other hand, it had cash of US$439.0m and US$245.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$2.13b.
While this might seem like a lot, it is not so bad since Ashland has a market capitalization of US$4.98b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
While Ashland's debt to EBITDA ratio (2.7) suggests that it uses some debt, its interest cover is very weak, at 1.2, suggesting high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Even worse, Ashland saw its EBIT tank 83% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Ashland can strengthen its balance sheet over time. 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. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, Ashland recorded free cash flow of 40% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Our View
To be frank both Ashland's interest cover and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least its conversion of EBIT to free cash flow is not so bad. Overall, we think it's fair to say that Ashland has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Ashland , and understanding them should be part of your investment process.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.