David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. As with many other companies Ascom Holding AG (VTX:ASCN) makes use of debt. But should shareholders be worried about its use of debt?
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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Ascom Holding's Net Debt?
The image below, which you can click on for greater detail, shows that at December 2018 Ascom Holding had debt of CHF20.0m, up from CHF18.0m in one year. But it also has CHF21.2m in cash to offset that, meaning it has CHF1.20m net cash.
How Healthy Is Ascom Holding's Balance Sheet?
According to the last reported balance sheet, Ascom Holding had liabilities of CHF83.9m due within 12 months, and liabilities of CHF51.3m due beyond 12 months. Offsetting this, it had CHF21.2m in cash and CHF99.3m in receivables that were due within 12 months. So its liabilities total CHF14.7m more than the combination of its cash and short-term receivables.
Since publicly traded Ascom Holding shares are worth a total of CHF461.8m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Ascom Holding boasts net cash, so it's fair to say it does not have a heavy debt load!
But the bad news is that Ascom Holding has seen its EBIT plunge 20% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Ascom Holding 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. While Ascom Holding 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. In the last three years, Ascom Holding created free cash flow amounting to 3.4% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Ascom Holding has CHF1.2m in net cash. So while Ascom Holding does not have a great balance sheet, it's certainly not too bad. Given Ascom Holding has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
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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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.