Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 can see that Advanced Emissions Solutions, Inc. (NASDAQ:ADES) does use debt in its business. But should shareholders be worried about its use of debt?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.
What Is Advanced Emissions Solutions's Net Debt?
The image below, which you can click on for greater detail, shows that Advanced Emissions Solutions had debt of US$19.8m at the end of September 2020, a reduction from US$43.3m over a year. However, it also had US$15.0m in cash, and so its net debt is US$4.79m.
How Healthy Is Advanced Emissions Solutions's Balance Sheet?
We can see from the most recent balance sheet that Advanced Emissions Solutions had liabilities of US$40.1m falling due within a year, and liabilities of US$31.2m due beyond that. Offsetting this, it had US$15.0m in cash and US$13.9m in receivables that were due within 12 months. So it has liabilities totalling US$42.4m more than its cash and near-term receivables, combined.
Advanced Emissions Solutions has a market capitalization of US$94.7m, 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. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Advanced Emissions Solutions will need earnings to service that debt. 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.
In the last year Advanced Emissions Solutions had a loss before interest and tax, and actually shrunk its revenue by 8.4%, to US$59m. That's not what we would hope to see.
Over the last twelve months Advanced Emissions Solutions produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable US$11m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of US$12m. In the meantime, we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Advanced Emissions Solutions is showing 2 warning signs in our investment analysis , you should know about...
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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What are the risks and opportunities for Advanced Emissions Solutions?
Earnings have declined by 16.2% per year over past 5 years
Does not have a meaningful market cap ($57M)
Profit margins (0.07%) are lower than last year (55.7%)
Large one-off items impacting financial results
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