AusGroup (SGX:5GJ) Is Making Moderate Use Of Debt

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. We note that AusGroup Limited (SGX:5GJ) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for AusGroup

What Is AusGroup's Debt?

As you can see below, AusGroup had AU$64.9m of debt at December 2020, down from AU$83.5m a year prior. On the flip side, it has AU$18.0m in cash leading to net debt of about AU$46.8m.

A Look At AusGroup's Liabilities

Zooming in on the latest balance sheet data, we can see that AusGroup had liabilities of AU$35.4m due within 12 months and liabilities of AU$76.9m due beyond that. On the other hand, it had cash of AU$18.0m and AU$44.7m worth of receivables due within a year. So it has liabilities totalling AU$49.6m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of AU$79.7m, so it does suggest shareholders should keep an eye on AusGroup's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since AusGroup 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.

In the last year AusGroup had a loss before interest and tax, and actually shrunk its revenue by 36%, to AU$192m. That makes us nervous, to say the least.

Caveat Emptor

Not only did AusGroup's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable AU$11m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of AU$63m. In the meantime, we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for AusGroup you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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