Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, Advanced Drainage Systems, Inc. (NYSE:WMS) does carry debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Advanced Drainage Systems's Net Debt?
The image below, which you can click on for greater detail, shows that Advanced Drainage Systems had debt of US$256.3m at the end of June 2019, a reduction from US$384.4m over a year. However, it does have US$9.36m in cash offsetting this, leading to net debt of about US$246.9m.
How Healthy Is Advanced Drainage Systems's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Advanced Drainage Systems had liabilities of US$244.0m due within 12 months and liabilities of US$332.4m due beyond that. Offsetting this, it had US$9.36m in cash and US$231.8m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$335.2m.
Of course, Advanced Drainage Systems has a market capitalization of US$1.91b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Advanced Drainage Systems'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.
Over 12 months, Advanced Drainage Systems reported revenue of US$1.4b, which is a gain of 3.7%. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Importantly, Advanced Drainage Systems had negative earnings before interest and tax (EBIT), over the last year. To be specific the EBIT loss came in at US$120m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. For example, we would not want to see a repeat of last year's loss of-US$192.4m. In the meantime, we consider the stock very risky. For riskier companies like Advanced Drainage Systems I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.
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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