These 4 Measures Indicate That Austin Engineering (ASX:ANG) Is Using Debt Reasonably Well

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Austin Engineering Limited (ASX:ANG) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Austin Engineering

How Much Debt Does Austin Engineering Carry?

As you can see below, at the end of December 2022, Austin Engineering had AU$42.6m of debt, up from AU$30.2m a year ago. Click the image for more detail. On the flip side, it has AU$30.4m in cash leading to net debt of about AU$12.3m.

A Look At Austin Engineering's Liabilities

We can see from the most recent balance sheet that Austin Engineering had liabilities of AU$122.8m falling due within a year, and liabilities of AU$26.0m due beyond that. Offsetting this, it had AU$30.4m in cash and AU$59.3m in receivables that were due within 12 months. So its liabilities total AU$59.1m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Austin Engineering is worth AU$175.0m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Austin Engineering has a low net debt to EBITDA ratio of only 0.46. And its EBIT covers its interest expense a whopping 15.0 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Another good sign is that Austin Engineering has been able to increase its EBIT by 20% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Austin Engineering'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, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Austin Engineering barely recorded positive free cash flow, in total. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.

Our View

Austin Engineering's interest cover was a real positive on this analysis, as was its net debt to EBITDA. In contrast, our confidence was undermined by its apparent struggle to convert EBIT to free cash flow. When we consider all the elements mentioned above, it seems to us that Austin Engineering is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Austin Engineering's earnings per share history for free.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.