Is Action (WSE:ACT) A Risky Investment?

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, Action S.A. (WSE:ACT) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Action

How Much Debt Does Action Carry?

The image below, which you can click on for greater detail, shows that Action had debt of zł104.2m at the end of June 2020, a reduction from zł112.5m over a year. However, it does have zł122.6m in cash offsetting this, leading to net cash of zł18.3m.

How Healthy Is Action's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Action had liabilities of zł477.1m due within 12 months and liabilities of zł34.0k due beyond that. Offsetting these obligations, it had cash of zł122.6m as well as receivables valued at zł151.4m due within 12 months. So it has liabilities totalling zł203.2m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the zł77.0m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Action would likely require a major re-capitalisation if it had to pay its creditors today. Action boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

Although Action made a loss at the EBIT level, last year, it was also good to see that it generated zł3.1m in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Action will need earnings to service that debt. 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 Action 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 last year, Action actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While Action does have more liabilities than liquid assets, it also has net cash of zł18.3m. And it impressed us with free cash flow of zł43m, being 1,398% of its EBIT. So while Action does not have a great balance sheet, it's certainly not too bad. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 3 warning signs we've spotted with Action .

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. 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.
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