Is AEM Holdings (SGX:AWX) 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. As with many other companies AEM Holdings Ltd (SGX:AWX) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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 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 AEM Holdings

How Much Debt Does AEM Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 AEM Holdings had S$81.3m of debt, an increase on S$11.3m, over one year. But on the other hand it also has S$217.9m in cash, leading to a S$136.6m net cash position.

How Strong Is AEM Holdings' Balance Sheet?

According to the last reported balance sheet, AEM Holdings had liabilities of S$235.2m due within 12 months, and liabilities of S$72.8m due beyond 12 months. Offsetting this, it had S$217.9m in cash and S$124.5m in receivables that were due within 12 months. So it actually has S$34.4m more liquid assets than total liabilities.

This short term liquidity is a sign that AEM Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that AEM Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that AEM Holdings has boosted its EBIT by 68%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if AEM Holdings can strengthen its balance sheet over time. 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. While AEM Holdings 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 most recent three years, AEM Holdings recorded free cash flow worth 50% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case AEM Holdings has S$136.6m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 68% over the last year. So is AEM Holdings's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with AEM Holdings , and understanding them should be part of your investment process.

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.