Here's Why Atlas Engineered Products (CVE:AEP) Can Manage Its Debt Responsibly

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Atlas Engineered Products Ltd. (CVE:AEP) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Atlas Engineered Products

How Much Debt Does Atlas Engineered Products Carry?

You can click the graphic below for the historical numbers, but it shows that Atlas Engineered Products had CA$13.0m of debt in March 2023, down from CA$14.9m, one year before. However, it does have CA$16.4m in cash offsetting this, leading to net cash of CA$3.41m.

How Strong Is Atlas Engineered Products' Balance Sheet?

The latest balance sheet data shows that Atlas Engineered Products had liabilities of CA$6.84m due within a year, and liabilities of CA$14.1m falling due after that. Offsetting these obligations, it had cash of CA$16.4m as well as receivables valued at CA$6.38m due within 12 months. So it can boast CA$1.87m more liquid assets than total liabilities.

This surplus suggests that Atlas Engineered Products has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Atlas Engineered Products boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Atlas Engineered Products saw its EBIT decline by 6.9% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 Atlas Engineered Products's ability to maintain a healthy balance sheet going forward. 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 Atlas Engineered Products 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 most recent three years, Atlas Engineered Products recorded free cash flow worth 72% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Atlas Engineered Products has net cash of CA$3.41m, as well as more liquid assets than liabilities. The cherry on top was that in converted 72% of that EBIT to free cash flow, bringing in CA$8.3m. So is Atlas Engineered Products's debt a risk? It doesn't seem so to us. 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 1 warning sign for Atlas Engineered Products you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.