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 APC Technology Group PLC (LON:APC) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. When we think about a company’s use of debt, we first look at cash and debt together.
How Much Debt Does APC Technology Group Carry?
As you can see below, APC Technology Group had UK£3.60m of debt at February 2019, down from UK£4.27m a year prior. However, because it has a cash reserve of UK£845.0k, its net debt is less, at about UK£2.75m.
How Healthy Is APC Technology Group’s Balance Sheet?
According to the last reported balance sheet, APC Technology Group had liabilities of UK£8.06m due within 12 months, and liabilities of UK£110.0k due beyond 12 months. Offsetting these obligations, it had cash of UK£845.0k as well as receivables valued at UK£3.84m due within 12 months. So it has liabilities totalling UK£3.49m more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since APC Technology Group has a market capitalization of UK£14.2m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it’s clear that we should definitely closely examine whether it can manage its debt without dilution.
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.
APC Technology Group has net debt worth 2.0 times EBITDA, which isn’t too much, but its interest cover looks a bit on the low side, with EBIT at only 4.9 times the interest expense. While these numbers do not alarm us, it’s worth noting that the cost of the company’s debt is having a real impact. Importantly, APC Technology Group grew its EBIT by 47% over the last twelve months, and that growth will make it easier to handle its 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 APC Technology Group 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, APC Technology Group saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
Based on what we’ve seen APC Technology Group is not finding it easy conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. There’s no doubt that its ability to grow its EBIT is pretty flash. Looking at all this data makes us feel a little cautious about APC Technology Group’s debt levels. While we appreciate debt can enhance returns on equity, we’d suggest that shareholders keep close watch on its debt levels, lest they increase. Over time, share prices tend to follow earnings per share, so if you’re interested in APC Technology Group, you may well want to click here to check an interactive graph of its earnings per share history.
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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