Is Ariadne Australia (ASX:ARA) A Risky Investment?

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. Importantly, Ariadne Australia Limited (ASX:ARA) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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, 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.

Check out our latest analysis for Ariadne Australia

What Is Ariadne Australia's Net Debt?

As you can see below, at the end of December 2020, Ariadne Australia had AU$18.2m of debt, up from AU$4.85m a year ago. Click the image for more detail. But it also has AU$31.2m in cash to offset that, meaning it has AU$12.9m net cash.

How Healthy Is Ariadne Australia's Balance Sheet?

We can see from the most recent balance sheet that Ariadne Australia had liabilities of AU$8.14m falling due within a year, and liabilities of AU$27.4m due beyond that. Offsetting these obligations, it had cash of AU$31.2m as well as receivables valued at AU$1.79m due within 12 months. So its liabilities total AU$2.54m more than the combination of its cash and short-term receivables.

Since publicly traded Ariadne Australia shares are worth a total of AU$107.0m, 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. While it does have liabilities worth noting, Ariadne Australia also has more cash than debt, so we're pretty confident it can manage its debt safely.

Notably, Ariadne Australia made a loss at the EBIT level, last year, but improved that to positive EBIT of AU$1.1m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Ariadne Australia will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Ariadne Australia may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Ariadne Australia actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Ariadne Australia has AU$12.9m in net cash. And it impressed us with free cash flow of AU$2.6m, being 230% of its EBIT. So we are not troubled with Ariadne Australia's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Ariadne Australia is showing 2 warning signs in our investment analysis , and 1 of those is concerning...

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. 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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