Is Accent Group (ASX:AX1) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Accent Group Limited (ASX:AX1) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Accent Group

What Is Accent Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Accent Group had AU$71.1m of debt in December 2020, down from AU$91.4m, one year before. But it also has AU$72.8m in cash to offset that, meaning it has AU$1.66m net cash.

How Strong Is Accent Group's Balance Sheet?

The latest balance sheet data shows that Accent Group had liabilities of AU$283.5m due within a year, and liabilities of AU$328.2m falling due after that. Offsetting this, it had AU$72.8m in cash and AU$38.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$500.3m.

While this might seem like a lot, it is not so bad since Accent Group has a market capitalization of AU$1.27b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Accent Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

Another good sign is that Accent Group has been able to increase its EBIT by 30% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Accent Group 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Accent Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Accent Group actually produced more free cash flow than EBIT. 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 Accent Group does have more liabilities than liquid assets, it also has net cash of AU$1.66m. The cherry on top was that in converted 115% of that EBIT to free cash flow, bringing in AU$177m. So we don't think Accent Group's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Accent Group .

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. 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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