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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Associated British Foods plc (LON:ABF) does use debt in its business. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Associated British Foods's Net Debt?
The image below, which you can click on for greater detail, shows that Associated British Foods had debt of UK£406.0m at the end of September 2021, a reduction from UK£472.0m over a year. But on the other hand it also has UK£2.31b in cash, leading to a UK£1.90b net cash position.
A Look At Associated British Foods' Liabilities
According to the last reported balance sheet, Associated British Foods had liabilities of UK£3.28b due within 12 months, and liabilities of UK£3.61b due beyond 12 months. On the other hand, it had cash of UK£2.31b and UK£1.27b worth of receivables due within a year. So it has liabilities totalling UK£3.31b more than its cash and near-term receivables, combined.
Associated British Foods has a very large market capitalization of UK£15.2b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Associated British Foods boasts net cash, so it's fair to say it does not have a heavy debt load!
Associated British Foods's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. 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 Associated British Foods's ability to maintain a healthy balance sheet going forward. 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. While Associated British Foods 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 three years, Associated British Foods generated free cash flow amounting to a very robust 87% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
Although Associated British Foods's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of UK£1.90b. The cherry on top was that in converted 87% of that EBIT to free cash flow, bringing in UK£786m. So we don't have any problem with Associated British Foods's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Associated British Foods that you should be aware of.
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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