Here's Why Apollo Micro Systems (NSE:APOLLO) Has A Meaningful Debt Burden

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Apollo Micro Systems Limited (NSE:APOLLO) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Apollo Micro Systems

How Much Debt Does Apollo Micro Systems Carry?

As you can see below, at the end of September 2021, Apollo Micro Systems had ₹1.18b of debt, up from ₹1.09b a year ago. Click the image for more detail. However, because it has a cash reserve of ₹162.0m, its net debt is less, at about ₹1.01b.

A Look At Apollo Micro Systems' Liabilities

Zooming in on the latest balance sheet data, we can see that Apollo Micro Systems had liabilities of ₹2.41b due within 12 months and liabilities of ₹190.9m due beyond that. Offsetting these obligations, it had cash of ₹162.0m as well as receivables valued at ₹1.39b due within 12 months. So it has liabilities totalling ₹1.04b more than its cash and near-term receivables, combined.

Apollo Micro Systems has a market capitalization of ₹2.59b, 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Apollo Micro Systems's debt is 2.6 times its EBITDA, and its EBIT cover its interest expense 2.7 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Investors should also be troubled by the fact that Apollo Micro Systems saw its EBIT drop by 11% over the last twelve months. If things keep going like that, handling the debt will about as easy as bundling an angry house cat into its travel box. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Apollo Micro Systems will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Apollo Micro Systems burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Mulling over Apollo Micro Systems's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. But at least its level of total liabilities is not so bad. We're quite clear that we consider Apollo Micro Systems to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Apollo Micro Systems (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.