Does ACS Actividades de Construcción y Servicios (BME:ACS) Have A Healthy Balance Sheet?

Warren Buffett famously said, '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. We can see that ACS, Actividades de Construcción y Servicios, S.A. (BME:ACS) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. 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 ACS Actividades de Construcción y Servicios

What Is ACS Actividades de Construcción y Servicios's Debt?

You can click the graphic below for the historical numbers, but it shows that ACS Actividades de Construcción y Servicios had €10.1b of debt in September 2023, down from €11.0b, one year before. However, it does have €9.43b in cash offsetting this, leading to net debt of about €700.0m.

How Strong Is ACS Actividades de Construcción y Servicios' Balance Sheet?

The latest balance sheet data shows that ACS Actividades de Construcción y Servicios had liabilities of €6.07b due within a year, and liabilities of €14.0b falling due after that. On the other hand, it had cash of €9.43b and €9.56b worth of receivables due within a year. So it has liabilities totalling €1.10b more than its cash and near-term receivables, combined.

Since publicly traded ACS Actividades de Construcción y Servicios shares are worth a very impressive total of €9.78b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Given net debt is only 0.64 times EBITDA, it is initially surprising to see that ACS Actividades de Construcción y Servicios's EBIT has low interest coverage of 1.4 times. So while we're not necessarily alarmed we think that its debt is far from trivial. Shareholders should be aware that ACS Actividades de Construcción y Servicios's EBIT was down 57% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine ACS Actividades de Construcción y Servicios'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, 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. Over the most recent three years, ACS Actividades de Construcción y Servicios recorded free cash flow worth 70% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

We weren't impressed with ACS Actividades de Construcción y Servicios's interest cover, and its EBIT growth rate made us cautious. But its conversion of EBIT to free cash flow was significantly redeeming. When we consider all the factors mentioned above, we do feel a bit cautious about ACS Actividades de Construcción y Servicios's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for ACS Actividades de Construcción y Servicios you should know about.

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.