Is Armstrong Flooring (NYSE:AFI) Using Too Much 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.' 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. We note that Armstrong Flooring, Inc. (NYSE:AFI) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Armstrong Flooring

What Is Armstrong Flooring's Net Debt?

As you can see below, Armstrong Flooring had US$51.9m of debt at March 2021, down from US$72.5m a year prior. However, it also had US$16.7m in cash, and so its net debt is US$35.2m.

How Strong Is Armstrong Flooring's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Armstrong Flooring had liabilities of US$125.0m due within 12 months and liabilities of US$118.2m due beyond that. Offsetting these obligations, it had cash of US$16.7m as well as receivables valued at US$57.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$168.8m.

Given this deficit is actually higher than the company's market capitalization of US$129.0m, we think shareholders really should watch Armstrong Flooring's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Armstrong Flooring will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Armstrong Flooring made a loss at the EBIT level, and saw its revenue drop to US$595m, which is a fall of 4.5%. We would much prefer see growth.

Caveat Emptor

Over the last twelve months Armstrong Flooring produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable US$59m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of US$61m over the last twelve months. So suffice it to say we consider the stock to be risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Armstrong Flooring (2 are significant!) that you should be aware of before investing here.

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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