Auditors Are Concerned About AMA Group (ASX:AMA)

When AMA Group Limited (ASX:AMA) reported its results to June 2021 its auditors, KPMG LLP - Klynveld Peat Marwick Goerdeler could not be sure that it would be able to continue as a going concern in the next year. Thus we can say that, based on the results to that date, the company should raise capital or otherwise raise cash, without much delay.

Since the company probably needs cash fairly quickly, it may be in a position where it has to accept whatever terms it can get. So shareholders should absolutely be taking a close look at how risky the balance sheet is. The biggest concern we would have is the company's debt, since its lenders might force the company into administration if it cannot repay them.

View our latest analysis for AMA Group

How Much Debt Does AMA Group Carry?

The image below, which you can click on for greater detail, shows that AMA Group had debt of AU$270.2m at the end of June 2021, a reduction from AU$385.7m over a year. However, it does have AU$64.2m in cash offsetting this, leading to net debt of about AU$206.0m.

How Healthy Is AMA Group's Balance Sheet?

We can see from the most recent balance sheet that AMA Group had liabilities of AU$233.7m falling due within a year, and liabilities of AU$642.5m due beyond that. Offsetting this, it had AU$64.2m in cash and AU$74.5m in receivables that were due within 12 months. So it has liabilities totalling AU$737.6m more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the AU$328.5m 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 definitely think shareholders need to watch this one closely. At the end of the day, AMA Group would probably need a major re-capitalization if its creditors were to demand repayment.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While AMA Group's debt to EBITDA ratio (2.7) suggests that it uses some debt, its interest cover is very weak, at 1.2, suggesting high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. The silver lining is that AMA Group grew its EBIT by 353% last year, which nourishing like the idealism of youth. If it can keep walking that path it will be in a position to shed its debt with relative ease. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if AMA Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, AMA Group actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

While AMA Group's level of total liabilities has us nervous. To wit both its conversion of EBIT to free cash flow and EBIT growth rate were encouraging signs. Taking the abovementioned factors together we do think AMA Group's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. Some investors may be interested in buying high risk stocks at the right price, but we prefer to avoid a company after its auditor has expressed any uncertainty about its ability to continue as a going concern. We prefer to invest in companies that ensure the balance sheet remains healthier than that. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for AMA Group you should know about.

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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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.
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