Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Atlas Arteria Limited (ASX:ALX) does use debt in its business. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.
How Much Debt Does Atlas Arteria Carry?
As you can see below, at the end of December 2018, Atlas Arteria had AU$2.18b of debt, up from AU$1.73b a year ago. Click the image for more detail. However, because it has a cash reserve of AU$186.5m, its net debt is less, at about AU$1.99b.
How Strong Is Atlas Arteria's Balance Sheet?
We can see from the most recent balance sheet that Atlas Arteria had liabilities of AU$115.3m falling due within a year, and liabilities of AU$2.18b due beyond that. On the other hand, it had cash of AU$186.5m and AU$1.77m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$2.11b.
While this might seem like a lot, it is not so bad since Atlas Arteria has a market capitalization of AU$5.46b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. 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 Atlas Arteria 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.
Over 12 months, Atlas Arteria reported revenue of AU$132m, which is a gain of 59%. With any luck the company will be able to grow its way to profitability.
Despite the top line growth, Atlas Arteria still had negative earnings before interest and tax (EBIT), over the last year. To be specific the EBIT loss came in at AU$86m. 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. Surprisingly, we note that it actually reported positive free cash flow of AU$22m and a profit of AU$77m. So one might argue that there's still a chance it can get things on the right track. For riskier companies like Atlas Arteria 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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
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.