The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. As with many other companies A.G. BARR p.l.c. (LON:BAG) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. 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, 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.
How Much Debt Does A.G. BARR Carry?
You can click the graphic below for the historical numbers, but it shows that as of July 2020 A.G. BARR had UK£59.9m of debt, an increase on UK£4.40m, over one year. But on the other hand it also has UK£90.4m in cash, leading to a UK£30.5m net cash position.
How Strong Is A.G. BARR's Balance Sheet?
The latest balance sheet data shows that A.G. BARR had liabilities of UK£122.8m due within a year, and liabilities of UK£27.8m falling due after that. On the other hand, it had cash of UK£90.4m and UK£54.7m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£5.50m.
Having regard to A.G. BARR's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the UK£564.8m company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, A.G. BARR boasts net cash, so it's fair to say it does not have a heavy debt load!
While A.G. BARR doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. 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 A.G. BARR'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. A.G. BARR 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, A.G. BARR generated free cash flow amounting to a very robust 80% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
We could understand if investors are concerned about A.G. BARR's liabilities, but we can be reassured by the fact it has has net cash of UK£30.5m. The cherry on top was that in converted 80% of that EBIT to free cash flow, bringing in UK£43m. So we don't think A.G. BARR's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that A.G. BARR is showing 2 warning signs in our investment analysis , you should know about...
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
When trading A.G. BARR or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account.
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.