Here's Why ActivePort Group (ASX:ATV) Has A Meaningful Debt Burden

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.' 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 can see that ActivePort Group Ltd (ASX:ATV) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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 ActivePort Group

What Is ActivePort Group's Debt?

As you can see below, ActivePort Group had AU$3.90m of debt, at December 2023, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of AU$3.01m, its net debt is less, at about AU$883.0k.

How Healthy Is ActivePort Group's Balance Sheet?

The latest balance sheet data shows that ActivePort Group had liabilities of AU$9.10m due within a year, and liabilities of AU$1.06m falling due after that. Offsetting this, it had AU$3.01m in cash and AU$6.80m in receivables that were due within 12 months. So it has liabilities totalling AU$349.5k more than its cash and near-term receivables, combined.

Having regard to ActivePort Group's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the AU$27.9m company is short on cash, but still worth keeping an eye on the balance sheet.

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.

Given net debt is only 0.44 times EBITDA, it is initially surprising to see that ActivePort Group's EBIT has low interest coverage of 2.5 times. So while we're not necessarily alarmed we think that its debt is far from trivial. We also note that ActivePort Group improved its EBIT from a last year's loss to a positive AU$1.9m. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since ActivePort Group will need earnings to service that debt. 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's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Considering the last year, ActivePort Group actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

While ActivePort Group's interest cover makes us cautious about it, its track record of converting EBIT to free cash flow is no better. But on the brighter side of life, its net debt to EBITDA leaves us feeling more frolicsome. Looking at all the angles mentioned above, it does seem to us that ActivePort Group is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 4 warning signs for ActivePort Group you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.