Does Action Construction Equipment (NSE:ACE) Have A Healthy Balance Sheet?

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 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 Action Construction Equipment Limited (NSE:ACE) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Action Construction Equipment

How Much Debt Does Action Construction Equipment Carry?

As you can see below, Action Construction Equipment had ₹503.5m of debt at March 2021, down from ₹819.8m a year prior. However, its balance sheet shows it holds ₹638.6m in cash, so it actually has ₹135.1m net cash.

How Healthy Is Action Construction Equipment's Balance Sheet?

The latest balance sheet data shows that Action Construction Equipment had liabilities of ₹4.94b due within a year, and liabilities of ₹381.8m falling due after that. Offsetting these obligations, it had cash of ₹638.6m as well as receivables valued at ₹2.25b due within 12 months. So it has liabilities totalling ₹2.43b more than its cash and near-term receivables, combined.

Since publicly traded Action Construction Equipment shares are worth a total of ₹18.7b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Action Construction Equipment boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Action Construction Equipment has boosted its EBIT by 30%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Action Construction Equipment'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Action Construction Equipment 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. Over the last three years, Action Construction Equipment reported free cash flow worth 16% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

Although Action Construction Equipment's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of ₹135.1m. And it impressed us with its EBIT growth of 30% over the last year. So we are not troubled with Action Construction Equipment's debt use. We'd be motivated to research the stock further if we found out that Action Construction Equipment insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

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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