Ashley Services Group (ASX:ASH) Seems To Use Debt Quite Sensibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Ashley Services Group Limited (ASX:ASH) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Ashley Services Group

How Much Debt Does Ashley Services Group Carry?

The image below, which you can click on for greater detail, shows that at December 2023 Ashley Services Group had debt of AU$16.5m, up from AU$11.6m in one year. However, because it has a cash reserve of AU$844.0k, its net debt is less, at about AU$15.6m.

How Healthy Is Ashley Services Group's Balance Sheet?

We can see from the most recent balance sheet that Ashley Services Group had liabilities of AU$60.8m falling due within a year, and liabilities of AU$9.39m due beyond that. On the other hand, it had cash of AU$844.0k and AU$60.3m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$9.05m.

This deficit isn't so bad because Ashley Services Group is worth AU$36.7m, 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.

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.

Ashley Services Group has a low net debt to EBITDA ratio of only 0.93. And its EBIT covers its interest expense a whopping 10.9 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On the other hand, Ashley Services Group's EBIT dived 16%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Ashley Services Group's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Ashley Services Group produced sturdy free cash flow equating to 69% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Ashley Services Group's interest cover was a real positive on this analysis, as was its conversion of EBIT to free cash flow. But truth be told its EBIT growth rate had us nibbling our nails. Considering this range of data points, we think Ashley Services Group is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. For example, we've discovered 5 warning signs for Ashley Services Group that you should be aware of before investing here.

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.