Is AP Oil International (SGX:5AU) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, AP Oil International Limited (SGX:5AU) does carry debt. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

See our latest analysis for AP Oil International

What Is AP Oil International's Net Debt?

As you can see below, AP Oil International had S$6.20m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has S$35.7m in cash, leading to a S$29.5m net cash position.

How Healthy Is AP Oil International's Balance Sheet?

According to the last reported balance sheet, AP Oil International had liabilities of S$8.88m due within 12 months, and liabilities of S$11.2m due beyond 12 months. On the other hand, it had cash of S$35.7m and S$4.98m worth of receivables due within a year. So it can boast S$20.6m more liquid assets than total liabilities.

This surplus liquidity suggests that AP Oil International's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that AP Oil International has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for AP Oil International if management cannot prevent a repeat of the 54% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is AP Oil International's earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. AP Oil International 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, AP Oil International saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that AP Oil International has net cash of S$29.5m, as well as more liquid assets than liabilities. So we don't have any problem with AP Oil International's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for AP Oil International (1 doesn't sit too well with us) 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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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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