These 4 Measures Indicate That AdEPT Technology Group (LON:ADT) Is Using Debt Extensively

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.' 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 note that AdEPT Technology Group plc (LON:ADT) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for AdEPT Technology Group

What Is AdEPT Technology Group's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2021 AdEPT Technology Group had UK£41.8m of debt, an increase on UK£36.4m, over one year. On the flip side, it has UK£3.61m in cash leading to net debt of about UK£38.2m.

How Healthy Is AdEPT Technology Group's Balance Sheet?

The latest balance sheet data shows that AdEPT Technology Group had liabilities of UK£24.2m due within a year, and liabilities of UK£48.2m falling due after that. Offsetting this, it had UK£3.61m in cash and UK£18.2m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£50.6m.

Given this deficit is actually higher than the company's market capitalization of UK£48.3m, we think shareholders really should watch AdEPT Technology Group's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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.

Weak interest cover of 0.36 times and a disturbingly high net debt to EBITDA ratio of 5.3 hit our confidence in AdEPT Technology Group like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, AdEPT Technology Group saw its EBIT tank 77% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if AdEPT Technology Group 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, AdEPT Technology Group actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

On the face of it, AdEPT Technology Group's interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Overall, it seems to us that AdEPT Technology Group's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. Case in point: We've spotted 4 warning signs for AdEPT Technology Group you should be aware of, and 2 of them are concerning.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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.

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