Does Artesian Resources (NASDAQ:ARTN.A) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Artesian Resources Corporation (NASDAQ:ARTN.A) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Artesian Resources

How Much Debt Does Artesian Resources Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Artesian Resources had debt of US$168.2m, up from US$148.0m in one year. And it doesn't have much cash, so its net debt is about the same.

A Look At Artesian Resources' Liabilities

The latest balance sheet data shows that Artesian Resources had liabilities of US$43.6m due within a year, and liabilities of US$378.0m falling due after that. On the other hand, it had cash of US$249.0k and US$11.1m worth of receivables due within a year. So its liabilities total US$410.2m more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's US$351.0m market capitalization, you might well be inclined to review the balance sheet intently. 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Artesian Resources has a debt to EBITDA ratio of 4.3 and its EBIT covered its interest expense 3.7 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. However, one redeeming factor is that Artesian Resources grew its EBIT at 16% over the last 12 months, boosting its ability to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Artesian Resources's earnings that will influence how the balance sheet holds up in the future. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Artesian Resources burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

We'd go so far as to say Artesian Resources's conversion of EBIT to free cash flow was disappointing. But at least it's pretty decent at growing its EBIT; that's encouraging. We should also note that Water Utilities industry companies like Artesian Resources commonly do use debt without problems. Overall, it seems to us that Artesian Resources's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Artesian Resources .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. 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.
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