Health Check: How Prudently Does African and Overseas Enterprises (JSE:AOO) Use Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, African and Overseas Enterprises Limited (JSE:AOO) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for African and Overseas Enterprises

What Is African and Overseas Enterprises's Net Debt?

As you can see below, at the end of June 2020, African and Overseas Enterprises had R82.2m of debt, up from R75.2m a year ago. Click the image for more detail. However, it also had R72.6m in cash, and so its net debt is R9.56m.

How Healthy Is African and Overseas Enterprises's Balance Sheet?

The latest balance sheet data shows that African and Overseas Enterprises had liabilities of R153.5m due within a year, and liabilities of R378.8m falling due after that. On the other hand, it had cash of R72.6m and R25.4m worth of receivables due within a year. So it has liabilities totalling R434.3m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the R240.8m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, African and Overseas Enterprises would probably need a major re-capitalization if its creditors were to demand repayment. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since African and Overseas Enterprises 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 African and Overseas Enterprises had a loss before interest and tax, and actually shrunk its revenue by 15%, to R579m. That's not what we would hope to see.

Caveat Emptor

Not only did African and Overseas Enterprises's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping R77m. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. For example, we would not want to see a repeat of last year's loss of R43m. And until that time we think this is a risky stock. 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 learn about the 2 warning signs we've spotted with African and Overseas Enterprises (including 1 which is is significant) .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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