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

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 The a2 Milk Company Limited (NZSE:ATM) makes use of debt. But should shareholders be worried about its use of debt?

We check all companies for important risks. See what we found for a2 Milk in our free report.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does a2 Milk Carry?

The image below, which you can click on for greater detail, shows that at December 2024 a2 Milk had debt of NZ$66.8m, up from NZ$37.9m in one year. But it also has NZ$1.04b in cash to offset that, meaning it has NZ$975.3m net cash.

How Strong Is a2 Milk's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that a2 Milk had liabilities of NZ$473.9m due within 12 months and liabilities of NZ$66.7m due beyond that. Offsetting this, it had NZ$1.04b in cash and NZ$93.7m in receivables that were due within 12 months. So it actually has NZ$595.1m 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. Simply put, the fact that a2 Milk has more cash than debt is arguably a good indication that it can manage its debt safely.

See our latest analysis for a2 Milk

On the other hand, a2 Milk saw its EBIT drop by 2.4% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if a2 Milk can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While a2 Milk 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. During the last three years, a2 Milk generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case a2 Milk has NZ$975.3m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 86% of that EBIT to free cash flow, bringing in NZ$262m. So is a2 Milk's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in a2 Milk, you may well want to click here to check an interactive graph of its earnings per share history.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.