Legendary fund manager Li Lu (whom Charlie Munger supported) once said, âThe biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. We note that Accrol Group Holdings plc (LON: ACRL) has debt on its balance sheet. But the most important question is: what risk does this debt create?
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first step when considering a company’s debt levels is to consider its cash flow and debt together.
Check out our latest review for Accrol Group Holdings
What is the amount of debt held by Accrol Group Holdings?
The image below, which you can click for more details, shows Accrol Group Holdings owed Â£ 15.6million at the end of April 2021, a reduction from Â£ 23.4million sterling over one year. However, because he has a cash reserve of Â£ 7.60million, his net debt is less, at around Â£ 8.00million.
How healthy is Acrol Group Holdings’ balance sheet?
Zooming in on the latest balance sheet data, we can see that Accrol Group Holdings had a liability of Â£ 67.1million due within 12 months and a liability of Â£ 34.5million beyond. In return, he had Â£ 7.60 million in cash and Â£ 24.0 million in receivables due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by Â£ 70.1 million.
This deficit is not that big as Accrol Group Holdings is worth Â£ 123.7million, and could therefore probably raise enough capital to consolidate its balance sheet, should the need arise. But we absolutely want to keep our eyes open for indications that its debt is too risky.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
Accrol Group Holdings has a very low debt to EBITDA ratio of 1.0 so it is strange to see low interest coverage as last year’s EBIT was only 2.0 times interest expense . So while we are not necessarily alarmed, we think his debt is far from negligible. Notably, Acrol Group Holdings’ EBIT was higher than Elon Musk’s, gaining a whopping 1.339% from last year. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine Acrol Group Holdings’ ability to maintain a healthy balance sheet going forward. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to repay its debts; accounting profits are not enough. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Fortunately for all shareholders, Accrol Group Holdings has actually generated more free cash flow than EBIT over the past two years. This kind of cash conversion makes us as excited as the crowd when the pace drops at a Daft Punk concert.
Our point of view
Fortunately, Accrol Group Holdings’ impressive conversion of EBIT to free cash flow means it has the upper hand over its debt. But the hard truth is that we are concerned about its coverage of interest. Looking at all of the above factors together, it seems to us that Accrol Group Holdings can manage its debt quite comfortably. On the plus side, this leverage can increase returns to shareholders, but the potential downside is more risk of loss, so it’s worth watching the balance sheet. The balance sheet is clearly the area you need to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we discovered 3 warning signs for Accrol Group Holdings (2 are significant!) That you should know before investing here.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in the mentioned stocks.
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