Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Ecovyst Inc. (NYSE:ECVT) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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.

How Much Debt Does Ecovyst Carry?

As you can see below, Ecovyst had US$866.0m of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of US$129.7m, its net debt is less, at about US$736.3m.

How Strong Is Ecovyst's Balance Sheet?

We can see from the most recent balance sheet that Ecovyst had liabilities of US$111.8m falling due within a year, and liabilities of US$998.8m due beyond that. On the other hand, it had cash of US$129.7m and US$76.8m worth of receivables due within a year. So it has liabilities totalling US$904.2m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of US$926.3m, so it does suggest shareholders should keep an eye on Ecovyst's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Ecovyst's debt to EBITDA ratio (3.9) suggests that it uses some debt, its interest cover is very weak, at 2.1, suggesting high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Even more troubling is the fact that Ecovyst actually let its EBIT decrease by 8.1% over the last year. If it keeps going like that paying off its debt will be like running on a treadmill -- a lot of effort for not much advancement. 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 Ecovyst 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Ecovyst generated free cash flow amounting to a very robust 89% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

We'd go so far as to say Ecovyst's interest cover was disappointing. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Ecovyst stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Ecovyst is showing 1 warning sign in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.