Stock Analysis

Does Apiam Animal Health (ASX:AHX) Have A Healthy Balance Sheet?

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ASX:AHX
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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Apiam Animal Health Limited (ASX:AHX) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

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What Is Apiam Animal Health's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 Apiam Animal Health had AU$37.0m of debt, an increase on AU$25.1m, over one year. However, because it has a cash reserve of AU$2.51m, its net debt is less, at about AU$34.5m.

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ASX:AHX Debt to Equity History December 29th 2020

A Look At Apiam Animal Health's Liabilities

Zooming in on the latest balance sheet data, we can see that Apiam Animal Health had liabilities of AU$26.2m due within 12 months and liabilities of AU$46.3m due beyond that. On the other hand, it had cash of AU$2.51m and AU$12.1m worth of receivables due within a year. So its liabilities total AU$57.9m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of AU$73.7m, so it does suggest shareholders should keep an eye on Apiam Animal Health's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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.

Apiam Animal Health has a debt to EBITDA ratio of 3.1 and its EBIT covered its interest expense 5.7 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. We note that Apiam Animal Health grew its EBIT by 28% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Apiam Animal Health'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Apiam Animal Health produced sturdy free cash flow equating to 59% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

On our analysis Apiam Animal Health's EBIT growth rate should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to handle its total liabilities. We would also note that Healthcare industry companies like Apiam Animal Health commonly do use debt without problems. When we consider all the elements mentioned above, it seems to us that Apiam Animal Health is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 4 warning signs for Apiam Animal Health you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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