Ashtead Group (LON:AHT) Has A Somewhat Strained Balance Sheet

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, Ashtead Group plc (LON:AHT) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Ashtead Group

What Is Ashtead Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of July 2024 Ashtead Group had US$8.01b of debt, an increase on US$7.19b, over one year. And it doesn't have much cash, so its net debt is about the same.

A Look At Ashtead Group's Liabilities

We can see from the most recent balance sheet that Ashtead Group had liabilities of US$1.89b falling due within a year, and liabilities of US$12.9b due beyond that. Offsetting this, it had US$17.0m in cash and US$2.02b in receivables that were due within 12 months. So its liabilities total US$12.7b more than the combination of its cash and short-term receivables.

Ashtead Group has a very large market capitalization of US$32.9b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Ashtead Group has net debt worth 1.7 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 4.6 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Notably Ashtead Group's EBIT was pretty flat over the last year. Ideally it can diminish its debt load by kick-starting earnings growth. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Ashtead Group'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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Ashtead Group's free cash flow amounted to 20% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Ashtead Group's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example, its net debt to EBITDA is relatively strong. Looking at all the angles mentioned above, it does seem to us that Ashtead Group is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Ashtead Group you should be aware of.

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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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.