These 4 Measures Indicate That ARC Document Solutions (NYSE:ARC) Is Using Debt Reasonably Well
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 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 ARC Document Solutions, Inc. (NYSE:ARC) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for ARC Document Solutions
What Is ARC Document Solutions's Debt?
You can click the graphic below for the historical numbers, but it shows that ARC Document Solutions had US$45.0m of debt in March 2022, down from US$50.0m, one year before. But on the other hand it also has US$50.4m in cash, leading to a US$5.37m net cash position.
How Healthy Is ARC Document Solutions' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that ARC Document Solutions had liabilities of US$70.6m due within 12 months and liabilities of US$85.4m due beyond that. Offsetting these obligations, it had cash of US$50.4m as well as receivables valued at US$40.7m due within 12 months. So its liabilities total US$65.0m more than the combination of its cash and short-term receivables.
ARC Document Solutions has a market capitalization of US$108.6m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, ARC Document Solutions also has more cash than debt, so we're pretty confident it can manage its debt safely.
On top of that, ARC Document Solutions grew its EBIT by 44% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is ARC Document Solutions'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. While ARC Document Solutions has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, ARC Document Solutions actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Summing up
Although ARC Document Solutions's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$5.37m. And it impressed us with free cash flow of US$29m, being 283% of its EBIT. So we don't think ARC Document Solutions's use of debt is risky. 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. To that end, you should be aware of the 1 warning sign we've spotted with ARC Document Solutions .
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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