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.' 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. As with many other companies Acumentis Group Limited (ASX:ACU) makes use of debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Acumentis Group's Debt?
As you can see below, Acumentis Group had AU$3.25m of debt at December 2020, down from AU$5.18m a year prior. However, it does have AU$3.19m in cash offsetting this, leading to net debt of about AU$57.0k.
A Look At Acumentis Group's Liabilities
According to the last reported balance sheet, Acumentis Group had liabilities of AU$10.2m due within 12 months, and liabilities of AU$5.23m due beyond 12 months. Offsetting this, it had AU$3.19m in cash and AU$4.06m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$8.21m.
Acumentis Group has a market capitalization of AU$17.9m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. But either way, Acumentis Group has virtually no net debt, so it's fair to say it does not have a heavy debt load!
We also note that Acumentis Group improved its EBIT from a last year's loss to a positive AU$768k. When analysing debt levels, the balance sheet is the obvious place to start. But it is Acumentis 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Happily for any shareholders, Acumentis Group actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Acumentis Group's conversion of EBIT to free cash flow was a real positive on this analysis, as was its net debt to EBITDA. In contrast, our confidence was undermined by its apparent struggle to cover its interest expense with its EBIT. When we consider all the elements mentioned above, it seems to us that Acumentis Group is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Acumentis Group , and understanding them should be part of your investment process.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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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