Is African and Overseas Enterprises (JSE:AOO) Using Debt Sensibly?

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.' 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. As with many other companies African and Overseas Enterprises Limited (JSE:AOO) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for African and Overseas Enterprises

What Is African and Overseas Enterprises's Debt?

As you can see below, African and Overseas Enterprises had R78.6m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has R99.1m in cash, leading to a R20.4m net cash position.

How Strong Is African and Overseas Enterprises' Balance Sheet?

According to the last reported balance sheet, African and Overseas Enterprises had liabilities of R135.6m due within 12 months, and liabilities of R379.5m due beyond 12 months. Offsetting these obligations, it had cash of R99.1m as well as receivables valued at R26.8m due within 12 months. So it has liabilities totalling R389.2m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the R165.8m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, African and Overseas Enterprises would probably need a major re-capitalization if its creditors were to demand repayment. Given that African and Overseas Enterprises has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total. There's no doubt that we learn most about debt from the balance sheet. But it is African and Overseas Enterprises'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.

In the last year African and Overseas Enterprises had a loss before interest and tax, and actually shrunk its revenue by 38%, to R436m. That makes us nervous, to say the least.

So How Risky Is African and Overseas Enterprises?

Although African and Overseas Enterprises had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of R73m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. Given the lack of transparency around future revenue (and cashflow), we're nervous about this one, until it makes its first big sales. To us, it is a high risk play. 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. Be aware that African and Overseas Enterprises is showing 3 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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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