Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that EchoStar Corporation (NASDAQ:SATS) does have 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 incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is EchoStar's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 EchoStar had US$21.7b of debt, an increase on US$1.50b, over one year. However, it also had US$766.4m in cash, and so its net debt is US$20.9b.

How Healthy Is EchoStar's Balance Sheet?

According to the last reported balance sheet, EchoStar had liabilities of US$7.00b due within 12 months, and liabilities of US$28.7b due beyond 12 months. On the other hand, it had cash of US$766.4m and US$1.02b worth of receivables due within a year. So its liabilities total US$33.9b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the US$5.32b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, EchoStar would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Strangely EchoStar has a sky high EBITDA ratio of 13.6, implying high debt, but a strong interest coverage of 1k. So either it has access to very cheap long term debt or that interest expense is going to grow! Shareholders should be aware that EchoStar's EBIT was down 96% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine EchoStar's ability to maintain a healthy balance sheet going forward. 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. In the last three years, EchoStar created free cash flow amounting to 2.3% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

To be frank both EchoStar's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its interest cover is a good sign, and makes us more optimistic. After considering the datapoints discussed, we think EchoStar has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. Case in point: We've spotted 2 warning signs for EchoStar you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com