Acrow Formwork and Construction Services (ASX:ACF) Seems To Use Debt Quite Sensibly
Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Acrow Formwork and Construction Services Limited (ASX:ACF) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Acrow Formwork and Construction Services
What Is Acrow Formwork and Construction Services's Net Debt?
As you can see below, at the end of December 2018, Acrow Formwork and Construction Services had AU$7.07m of debt, up from none a year ago. Click the image for more detail. However, it also had AU$4.48m in cash, and so its net debt is AU$2.59m.
A Look At Acrow Formwork and Construction Services's Liabilities
Zooming in on the latest balance sheet data, we can see that Acrow Formwork and Construction Services had liabilities of AU$15.9m due within 12 months and liabilities of AU$9.85m due beyond that. Offsetting these obligations, it had cash of AU$4.48m as well as receivables valued at AU$11.8m due within 12 months. So its liabilities total AU$9.42m more than the combination of its cash and short-term receivables.
Since publicly traded Acrow Formwork and Construction Services shares are worth a total of AU$50.6m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Acrow Formwork and Construction Services has net debt worth 2.5 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 6.2 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Notably, Acrow Formwork and Construction Services made a loss at the EBIT level, last year, but improved that to positive EBIT of AU$5.5m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Acrow Formwork and Construction Services's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Looking at the most recent year, Acrow Formwork and Construction Services recorded free cash flow of 47% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
Our View
Acrow Formwork and Construction Services's interest cover was a real positive on this analysis, as was its level of total liabilities. On the other hand, its net debt to EBITDA makes us a little less comfortable about its debt. When we consider all the factors mentioned above, we do feel a bit cautious about Acrow Formwork and Construction Services's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. We'd be motivated to research the stock further if we found out that Acrow Formwork and Construction Services insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
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.
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If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
