Does ACO Group Berhad (KLSE:ACO) Have A Healthy Balance Sheet?

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 ACO Group Berhad (KLSE:ACO) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

Check out our latest analysis for ACO Group Berhad

What Is ACO Group Berhad's Net Debt?

The image below, which you can click on for greater detail, shows that ACO Group Berhad had debt of RM23.5m at the end of February 2021, a reduction from RM26.6m over a year. But it also has RM24.7m in cash to offset that, meaning it has RM1.19m net cash.

How Healthy Is ACO Group Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that ACO Group Berhad had liabilities of RM54.6m due within 12 months and liabilities of RM7.92m due beyond that. Offsetting this, it had RM24.7m in cash and RM36.2m in receivables that were due within 12 months. So its liabilities total RM1.68m more than the combination of its cash and short-term receivables.

This state of affairs indicates that ACO Group Berhad's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the RM94.7m company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, ACO Group Berhad also has more cash than debt, so we're pretty confident it can manage its debt safely.

Importantly, ACO Group Berhad's EBIT fell a jaw-dropping 51% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is ACO Group Berhad's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. ACO Group Berhad 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, ACO Group Berhad reported free cash flow worth 2.5% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

We could understand if investors are concerned about ACO Group Berhad's liabilities, but we can be reassured by the fact it has has net cash of RM1.19m. So although we see some areas for improvement, we're not too worried about ACO Group Berhad's balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for ACO Group Berhad that you should be aware of.

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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