Is ACS Actividades de Construcción y Servicios (BME:ACS) Using Too Much Debt?

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.' 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. Importantly, ACS, Actividades de Construcción y Servicios, S.A. (BME:ACS) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Our analysis indicates that ACS is potentially undervalued!

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

As you can see below, at the end of June 2022, ACS Actividades de Construcción y Servicios had €11.3b of debt, up from €10.8b a year ago. Click the image for more detail. But it also has €11.8b in cash to offset that, meaning it has €506.9m net cash.

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

Zooming in on the latest balance sheet data, we can see that ACS Actividades de Construcción y Servicios had liabilities of €19.7b due within 12 months and liabilities of €11.4b due beyond that. Offsetting these obligations, it had cash of €11.8b as well as receivables valued at €10.2b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €9.16b.

The deficiency here weighs heavily on the €5.89b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, ACS Actividades de Construcción y Servicios would probably need a major re-capitalization if its creditors were to demand repayment. Given that ACS Actividades de Construcción y Servicios has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

On top of that, ACS Actividades de Construcción y Servicios grew its EBIT by 59% over the last twelve months, and that growth will make it easier to handle its debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While ACS Actividades de Construcción y Servicios 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. In the last three years, ACS Actividades de Construcción y Servicios's free cash flow amounted to 35% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

Although ACS Actividades de Construcción y Servicios's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €506.9m. And we liked the look of last year's 59% year-on-year EBIT growth. So while ACS Actividades de Construcción y Servicios does not have a great balance sheet, it's certainly not too bad. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - ACS Actividades de Construcción y Servicios has 1 warning sign we think you should be aware of.

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. 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.