Is Action Construction Equipment (NSE:ACE) A Risky Investment?

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.' 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. Importantly, Action Construction Equipment Limited (NSE:ACE) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Action Construction Equipment

What Is Action Construction Equipment's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Action Construction Equipment had ₹1.14b of debt, an increase on ₹597.8m, over one year. But it also has ₹4.08b in cash to offset that, meaning it has ₹2.94b net cash.

A Look At Action Construction Equipment's Liabilities

Zooming in on the latest balance sheet data, we can see that Action Construction Equipment had liabilities of ₹9.19b due within 12 months and liabilities of ₹168.6m due beyond that. Offsetting this, it had ₹4.08b in cash and ₹2.07b in receivables that were due within 12 months. So its liabilities total ₹3.21b more than the combination of its cash and short-term receivables.

Having regard to Action Construction Equipment's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the ₹167.7b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Action Construction Equipment boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Action Construction Equipment grew its EBIT by 43% over the last twelve months, and that growth will make it easier to handle its debt. 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 Action Construction Equipment can strengthen its balance sheet over time. 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 most recent three years, Action Construction Equipment recorded free cash flow worth 65% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Action Construction Equipment has ₹2.94b in net cash. And we liked the look of last year's 43% year-on-year EBIT growth. So is Action Construction Equipment's debt a risk? It doesn't seem so to us. We'd be very excited to see if Action Construction Equipment insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.

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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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.