We Think Aristocrat Leisure (ASX:ALL) Can Manage Its Debt With Ease

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Aristocrat Leisure Limited (ASX:ALL) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Aristocrat Leisure

What Is Aristocrat Leisure's Debt?

You can click the graphic below for the historical numbers, but it shows that Aristocrat Leisure had AU$2.30b of debt in March 2023, down from AU$2.47b, one year before. However, its balance sheet shows it holds AU$2.77b in cash, so it actually has AU$466.4m net cash.

How Strong Is Aristocrat Leisure's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Aristocrat Leisure had liabilities of AU$1.26b due within 12 months and liabilities of AU$2.60b due beyond that. Offsetting this, it had AU$2.77b in cash and AU$1.09b in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.

Having regard to Aristocrat Leisure's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the AU$24.8b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Aristocrat Leisure boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Aristocrat Leisure grew its EBIT by 16% last year, making its debt load easier to handle. 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 Aristocrat Leisure can strengthen its balance sheet over time. 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. Aristocrat Leisure 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. During the last three years, Aristocrat Leisure generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

We could understand if investors are concerned about Aristocrat Leisure's liabilities, but we can be reassured by the fact it has has net cash of AU$466.4m. And it impressed us with free cash flow of AU$1.0b, being 83% of its EBIT. So we don't think Aristocrat Leisure's use of debt is risky. We'd be very excited to see if Aristocrat Leisure insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.

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.