Afarak Group (HEL:AFAGR) Could Easily Take On More 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.' 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 note that Afarak Group SE (HEL:AFAGR) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Afarak Group

How Much Debt Does Afarak Group Carry?

You can click the graphic below for the historical numbers, but it shows that Afarak Group had €1.78m of debt in December 2022, down from €38.2m, one year before. However, its balance sheet shows it holds €12.4m in cash, so it actually has €10.6m net cash.

A Look At Afarak Group's Liabilities

The latest balance sheet data shows that Afarak Group had liabilities of €21.2m due within a year, and liabilities of €33.7m falling due after that. On the other hand, it had cash of €12.4m and €23.1m worth of receivables due within a year. So it has liabilities totalling €19.5m more than its cash and near-term receivables, combined.

Given Afarak Group has a market capitalization of €145.1m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Afarak Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Afarak Group grew its EBIT by 669% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is Afarak Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Afarak 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. During the last two years, Afarak Group produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While Afarak Group does have more liabilities than liquid assets, it also has net cash of €10.6m. And we liked the look of last year's 669% year-on-year EBIT growth. So we don't think Afarak 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. For example, we've discovered 2 warning signs for Afarak Group (1 is concerning!) that you should be aware of before investing here.

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.