Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Allied Motion Technologies Inc. (NASDAQ:AMOT) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
View 2 warning signs we detected for Allied Motion Technologies
What Is Allied Motion Technologies's Debt?
The image below, which you can click on for greater detail, shows that at September 2019 Allied Motion Technologies had debt of US$117.0m, up from US$62.5 in one year. However, it does have US$8.58m in cash offsetting this, leading to net debt of about US$108.4m.
How Healthy Is Allied Motion Technologies's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Allied Motion Technologies had liabilities of US$48.2m due within 12 months and liabilities of US$146.2m due beyond that. Offsetting these obligations, it had cash of US$8.58m as well as receivables valued at US$56.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$129.9m.
Allied Motion Technologies has a market capitalization of US$465.6m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Allied Motion Technologies has a debt to EBITDA ratio of 2.6 and its EBIT covered its interest expense 5.7 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Allied Motion Technologies grew its EBIT by 8.6% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Allied Motion Technologies's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Allied Motion Technologies's free cash flow amounted to 48% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Our View
Allied Motion Technologies's EBIT growth rate was a real positive on this analysis, as was its interest cover. Having said that, its net debt to EBITDA somewhat sensitizes us to potential future risks to the balance sheet. Looking at all this data makes us feel a little cautious about Allied Motion Technologies's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. We'd be motivated to research the stock further if we found out that Allied Motion Technologies insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
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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