These 4 Measures Indicate That AFC-HD AMS Life Science (TYO:2927) Is Using Debt Reasonably Well

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. As with many other companies AFC-HD AMS Life Science Co., Ltd. (TYO:2927) makes use of debt. But the more important question is: how much risk is that debt creating?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

View our latest analysis for AFC-HD AMS Life Science

How Much Debt Does AFC-HD AMS Life Science Carry?

The chart below, which you can click on for greater detail, shows that AFC-HD AMS Life Science had JP¥3.95b in debt in August 2020; about the same as the year before. However, its balance sheet shows it holds JP¥4.73b in cash, so it actually has JP¥778.0m net cash.

A Look At AFC-HD AMS Life Science's Liabilities

The latest balance sheet data shows that AFC-HD AMS Life Science had liabilities of JP¥6.20b due within a year, and liabilities of JP¥1.88b falling due after that. On the other hand, it had cash of JP¥4.73b and JP¥2.13b worth of receivables due within a year. So it has liabilities totalling JP¥1.23b more than its cash and near-term receivables, combined.

Since publicly traded AFC-HD AMS Life Science shares are worth a total of JP¥9.43b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, AFC-HD AMS Life Science boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that AFC-HD AMS Life Science grew its EBIT by 12% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is AFC-HD AMS Life Science'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While AFC-HD AMS Life Science has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, AFC-HD AMS Life Science recorded free cash flow worth 70% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While AFC-HD AMS Life Science does have more liabilities than liquid assets, it also has net cash of JP¥778.0m. And it impressed us with free cash flow of JP¥918m, being 70% of its EBIT. So is AFC-HD AMS Life Science's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with AFC-HD AMS Life Science .

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.

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