The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. 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. As with many other companies AST Groupe (EPA:ASP) makes use of debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does AST Groupe Carry?
You can click the graphic below for the historical numbers, but it shows that as of December 2018 AST Groupe had €31.3m of debt, an increase on €22.5m, over one year. However, its balance sheet shows it holds €34.2m in cash, so it actually has €2.85m net cash.
How Strong Is AST Groupe's Balance Sheet?
According to the last reported balance sheet, AST Groupe had liabilities of €83.9m due within 12 months, and liabilities of €22.1m due beyond 12 months. Offsetting these obligations, it had cash of €34.2m as well as receivables valued at €39.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €32.7m.
This is a mountain of leverage relative to its market capitalization of €47.6m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, AST Groupe also has more cash than debt, so we're pretty confident it can manage its debt safely.
On top of that, AST Groupe grew its EBIT by 57% over the last twelve months, and that growth will make it easier to handle its debt. 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 AST Groupe 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. AST Groupe may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, AST Groupe recorded free cash flow worth 54% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Although AST Groupe's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €2.85m. And we liked the look of last year's 57% year-on-year EBIT growth. So we are not troubled with AST Groupe's debt use. Given AST Groupe 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.
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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