Does a2 Milk (NZSE:ATM) Have A Healthy Balance Sheet?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies The a2 Milk Company Limited (NZSE:ATM) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for a2 Milk

What Is a2 Milk's Net Debt?

As you can see below, a2 Milk had NZ$37.9m of debt at December 2023, down from NZ$106.2m a year prior. But it also has NZ$792.1m in cash to offset that, meaning it has NZ$754.2m net cash.

How Healthy Is a2 Milk's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that a2 Milk had liabilities of NZ$348.2m due within 12 months and liabilities of NZ$52.7m due beyond that. Offsetting these obligations, it had cash of NZ$792.1m as well as receivables valued at NZ$87.6m due within 12 months. So it actually has NZ$478.7m more liquid assets than total liabilities.

This short term liquidity is a sign that a2 Milk could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, a2 Milk boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that a2 Milk grew its EBIT by 11% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine a2 Milk's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. a2 Milk 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, a2 Milk actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case a2 Milk has NZ$754.2m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of NZ$160m, being 103% of its EBIT. So we don't think a2 Milk's use of debt is risky. Another factor that would give us confidence in a2 Milk would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.

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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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