Is Acuity Brands (NYSE:AYI) 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. We note that Acuity Brands, Inc. (NYSE:AYI) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 Acuity Brands

What Is Acuity Brands's Debt?

The chart below, which you can click on for greater detail, shows that Acuity Brands had US$496.3m in debt in November 2024; about the same as the year before. However, its balance sheet shows it holds US$935.6m in cash, so it actually has US$439.3m net cash.

How Healthy Is Acuity Brands' Balance Sheet?

The latest balance sheet data shows that Acuity Brands had liabilities of US$650.6m due within a year, and liabilities of US$750.3m falling due after that. Offsetting these obligations, it had cash of US$935.6m as well as receivables valued at US$534.7m due within 12 months. So it actually has US$69.4m more liquid assets than total liabilities.

This state of affairs indicates that Acuity Brands' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$10.1b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Acuity Brands boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Acuity Brands has increased its EBIT by 9.5% over twelve months, which should ease any concerns about debt repayment. 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 Acuity Brands's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Acuity Brands 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. During the last three years, Acuity Brands generated free cash flow amounting to a very robust 87% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Acuity Brands has US$439.3m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 87% of that EBIT to free cash flow, bringing in US$493m. So we don't think Acuity Brands's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Acuity Brands that 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. 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.