Does Downer EDI (ASX:DOW) Have A Healthy Balance Sheet?
David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 can see that Downer EDI Limited (ASX:DOW) does use debt in its business. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company 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.
How Much Debt Does Downer EDI Carry?
You can click the graphic below for the historical numbers, but it shows that Downer EDI had AU$1.11b of debt in June 2025, down from AU$1.32b, one year before. However, because it has a cash reserve of AU$857.2m, its net debt is less, at about AU$253.6m.
How Strong Is Downer EDI's Balance Sheet?
We can see from the most recent balance sheet that Downer EDI had liabilities of AU$3.36b falling due within a year, and liabilities of AU$876.3m due beyond that. On the other hand, it had cash of AU$857.2m and AU$1.80b worth of receivables due within a year. So its liabilities total AU$1.58b more than the combination of its cash and short-term receivables.
This deficit isn't so bad because Downer EDI is worth AU$5.29b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
View our latest analysis for Downer EDI
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
While Downer EDI's low debt to EBITDA ratio of 0.49 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 4.6 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. One way Downer EDI could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 19%, as it did over the last year. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Downer EDI'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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Downer EDI recorded free cash flow worth a fulsome 99% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
Our View
The good news is that Downer EDI's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But truth be told we feel its interest cover does undermine this impression a bit. When we consider the range of factors above, it looks like Downer EDI is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. For instance, we've identified 2 warning signs for Downer EDI that you should be aware of.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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.