Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We can see that OneAll International Limited (ASX:1AL) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is OneAll International's Debt?
As you can see below, at the end of December 2018, OneAll International had AU$10.8m of debt, up from AU$2.17m a year ago. Click the image for more detail. However, it also had AU$3.87m in cash, and so its net debt is AU$6.95m.
How Strong Is OneAll International's Balance Sheet?
The latest balance sheet data shows that OneAll International had liabilities of AU$14.6m due within a year, and liabilities of AU$3.46m falling due after that. Offsetting this, it had AU$3.87m in cash and AU$2.98m in receivables that were due within 12 months. So it has liabilities totalling AU$11.2m more than its cash and near-term receivables, combined.
Since publicly traded OneAll International shares are worth a total of AU$104.0m, 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.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
OneAll International's net debt is only 0.64 times its EBITDA. And its EBIT covers its interest expense a whopping 64.2 times over. So we're pretty relaxed about its super-conservative use of debt. Fortunately, OneAll International grew its EBIT by 9.4% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since OneAll International will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, OneAll International's free cash flow amounted to 38% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
OneAll International's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. Looking at all the aforementioned factors together, it strikes us that OneAll International can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. Given OneAll International 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.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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