Is Apollo Micro Systems (NSE:APOLLO) Using Too Much Debt?

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 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, Apollo Micro Systems Limited (NSE:APOLLO) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Apollo Micro Systems

What Is Apollo Micro Systems's Debt?

As you can see below, at the end of March 2024, Apollo Micro Systems had ₹1.98b of debt, up from ₹1.43b a year ago. Click the image for more detail. However, it also had ₹275.4m in cash, and so its net debt is ₹1.71b.

How Healthy Is Apollo Micro Systems' Balance Sheet?

The latest balance sheet data shows that Apollo Micro Systems had liabilities of ₹3.92b due within a year, and liabilities of ₹453.0m falling due after that. Offsetting these obligations, it had cash of ₹275.4m as well as receivables valued at ₹2.44b due within 12 months. So its liabilities total ₹1.66b more than the combination of its cash and short-term receivables.

Of course, Apollo Micro Systems has a market capitalization of ₹37.1b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Apollo Micro Systems has a quite reasonable net debt to EBITDA multiple of 2.0, its interest cover seems weak, at 2.4. This does suggest the company is paying fairly high interest rates. In any case, it's safe to say the company has meaningful debt. It is well worth noting that Apollo Micro Systems's EBIT shot up like bamboo after rain, gaining 34% in the last twelve months. That'll make it easier to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Apollo Micro Systems's earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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 investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Based on what we've seen Apollo Micro Systems is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to grow its EBIT is pretty flash. When we consider all the factors mentioned above, we do feel a bit cautious about Apollo Micro Systems's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. For example Apollo Micro Systems has 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.

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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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.

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