Here's Why AST Groupe (EPA:ASP) 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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that AST Groupe (EPA:ASP) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for AST Groupe

What Is AST Groupe's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2020 AST Groupe had debt of €40.9m, up from €35.2m in one year. But on the other hand it also has €47.9m in cash, leading to a €6.98m net cash position.

A Look At AST Groupe's Liabilities

We can see from the most recent balance sheet that AST Groupe had liabilities of €84.8m falling due within a year, and liabilities of €29.9m due beyond that. Offsetting this, it had €47.9m in cash and €31.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €35.5m.

This is a mountain of leverage relative to its market capitalization of €49.5m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, AST Groupe boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, AST Groupe's EBIT dived 16%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if AST Groupe can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. AST Groupe may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, AST Groupe 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 AST Groupe does have more liabilities than liquid assets, it also has net cash of €6.98m. And it impressed us with free cash flow of €12m, being 72% of its EBIT. So we don't have any problem with AST Groupe's use of debt. 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 3 warning signs for AST Groupe that you should be aware of before investing here.

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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