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. When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that AdvanSix Inc. (NYSE:ASIX) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is AdvanSix's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 AdvanSix had US$255.0m of debt, an increase on US$210.0m, over one year. On the flip side, it has US$17.1m in cash leading to net debt of about US$237.9m.
How Healthy Is AdvanSix's Balance Sheet?
According to the last reported balance sheet, AdvanSix had liabilities of US$253.7m due within 12 months, and liabilities of US$488.6m due beyond 12 months. Offsetting these obligations, it had cash of US$17.1m as well as receivables valued at US$127.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$597.7m.
This is a mountain of leverage relative to its market capitalization of US$660.6m. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
AdvanSix's net debt to EBITDA ratio of about 1.8 suggests only moderate use of debt. And its strong interest cover of 14.7 times, makes us even more comfortable. Shareholders should be aware that AdvanSix's EBIT was down 37% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if AdvanSix can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, AdvanSix's free cash flow amounted to 49% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
We'd go so far as to say AdvanSix's EBIT growth rate was disappointing. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Once we consider all the factors above, together, it seems to us that AdvanSix's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. Given our hesitation about the stock, it would be good to know if AdvanSix insiders have sold any shares recently. You click here to find out if insiders have sold recently.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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