Does Euroseas (NASDAQ: ESEA) have a healthy balance sheet?

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Legendary fund manager Li Lu (whom Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital.” When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We can see that Euroseas Ltd. (NASDAQ: ESEA) uses debt in its business. But does this debt worry shareholders?

What risk does debt entail?

Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. If things really go wrong, lenders can take over the business. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. Of course, many companies use debt to finance their growth without negative consequences. When we look at debt levels, we first look at cash and debt levels, together.

What is Euroseas’ net debt?

As you can see below, Euroseas had a debt of US $ 59.5 million in September 2021, up from US $ 75.6 million the year before. However, it has $ 5.88 million in cash offsetting that, leading to net debt of around $ 53.6 million.

NasdaqCM: History of debt to equity of the ESEA January 6, 2022

Is Euroseas’ balance sheet healthy?

Zooming in on the latest balance sheet data, we can see that Euroseas had a liability of US $ 21.6 million due within 12 months and a liability of US $ 44.4 million beyond. In return, he had $ 5.88 million in cash and $ 2.75 million in receivables due within 12 months. Its liabilities therefore total US $ 57.4 million more than the combination of its cash and short-term receivables.

Euroseas has a market capitalization of US $ 185.9 million, so it could most likely raise funds to improve its balance sheet, should the need arise. However, it is always worth taking a close look at your ability to repay your debt.

We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its earnings before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). Thus, we look at debt versus earnings with and without amortization expenses.

Euroseas’ net debt to EBITDA ratio of around 1.9 suggests only moderate use of debt. And its imposing EBIT of 10.1 times its interest costs, means the debt load is as light as a peacock feather. Fortunately, Euroseas is increasing its EBIT faster than former Australian Prime Minister Bob Hawke, with a gain of 453% in the last twelve months. When analyzing debt levels, the balance sheet is the obvious place to start. But it is future profits, more than anything, that will determine Euroseas’ ability to maintain a healthy balance sheet in the future. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.

Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. In the last three years, Euroseas has recorded a total significant negative free cash flow. While investors no doubt expect this situation to reverse in due course, it clearly means that its use of debt is riskier.

Our point of view

Based on what we have seen, Euroseas does not find it easy, given its conversion from EBIT to free cash flow, but the other factors we have considered give us cause for optimism. In particular, we are dazzled by its growth rate of EBIT. When we consider all of the factors mentioned above, we feel a little cautious about Euroseas’ use of debt. While we understand that debt can improve returns on equity, we suggest shareholders watch their debt level closely, lest they increase. When analyzing debt levels, the balance sheet is the obvious place to start. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we have identified 3 warning signs for Euroseas that you need to be aware of.

At the end of the day, it’s often best to focus on businesses that don’t have net debt. You can access our special list of these companies (all with a history of profit 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 using only 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 into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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