Does ALS (ASX:ALQ) Have A Healthy Balance Sheet?

Warren Buffett famously said, '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 note that ALS Limited (ASX:ALQ) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for ALS

What Is ALS's Debt?

As you can see below, ALS had AU$821.5m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, it does have AU$146.7m in cash offsetting this, leading to net debt of about AU$674.8m.

How Strong Is ALS' Balance Sheet?

We can see from the most recent balance sheet that ALS had liabilities of AU$553.9m falling due within a year, and liabilities of AU$826.7m due beyond that. Offsetting this, it had AU$146.7m in cash and AU$338.3m in receivables that were due within 12 months. So it has liabilities totalling AU$895.6m more than its cash and near-term receivables, combined.

Since publicly traded ALS shares are worth a total of AU$4.89b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

ALS's net debt is sitting at a very reasonable 1.9 times its EBITDA, while its EBIT covered its interest expense just 6.3 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Unfortunately, ALS saw its EBIT slide 8.4% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine ALS's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, ALS recorded free cash flow of 49% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

ALS's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we thought its interest cover was a positive. When we consider all the factors mentioned above, we do feel a bit cautious about ALS's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that ALS is showing 3 warning signs in our investment analysis , you should know about...

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. 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.
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