Does Avon Rubber (LON:AVON) Have A Healthy 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.' 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 Avon Rubber p.l.c. (LON:AVON) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Avon Rubber

How Much Debt Does Avon Rubber Carry?

As you can see below, at the end of September 2020, Avon Rubber had UK£31.0m of debt, up from UK£100.0k a year ago. Click the image for more detail. But on the other hand it also has UK£147.0m in cash, leading to a UK£116.0m net cash position.

How Healthy Is Avon Rubber's Balance Sheet?

According to the last reported balance sheet, Avon Rubber had liabilities of UK£79.6m due within 12 months, and liabilities of UK£97.1m due beyond 12 months. On the other hand, it had cash of UK£147.0m and UK£33.2m worth of receivables due within a year. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

Having regard to Avon Rubber's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the UK£995.3m company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Avon Rubber has more cash than debt is arguably a good indication that it can manage its debt safely.

One way Avon Rubber could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 12%, as it did over the last year. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Avon Rubber can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Avon Rubber 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. During the last three years, Avon Rubber produced sturdy free cash flow equating to 52% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Avon Rubber has net cash of UK£116.0m, as well as more liquid assets than liabilities. On top of that, it increased its EBIT by 12% in the last twelve months. So we don't have any problem with Avon Rubber'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 instance, we've identified 4 warning signs for Avon Rubber (1 is potentially serious) 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. 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.
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