Is Augean (LON: AUG) a risky investment?
Some say volatility, rather than debt, is the best way to view risk as an investor, but Warren Buffett said “volatility is far from risk.” So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. We notice that Augean plc (LON: AUG) has debt on its balance sheet. But does this debt worry shareholders?
What risk does debt entail?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, many companies use debt to finance their growth without negative consequences. When we think of a business’s use of debt, we first look at cash flow and debt together.
See our latest analysis for Augean
What is Augean’s net debt?
As you can see below, Augean had £ 13.3million in debt as of December 2020, up from £ 34.8million the year before. But he also has £ 19.7million in cash to make up for that, meaning he has a net cash of £ 6.39million.
How healthy is Augean’s track record?
The latest balance sheet data shows Augean had debts of £ 35.1million due within one year, and debts of £ 17.0million falling due after that. In return, he had £ 19.7 million in cash and £ 15.0 million in receivables due within 12 months. It therefore has liabilities totaling £ 17.4million more than its cash and short-term receivables combined.
Given that the listed Augean shares are worth a total of £ 299.1million, it seems unlikely that this level of liabilities will be a major threat. However, we think it’s worth keeping an eye on the strength of its balance sheet as it can change over time. Despite her notable liabilities, Augean has a net cash flow, so it’s fair to say that she doesn’t have a heavy debt load!
It was also good to see that despite losing money on the EBIT line last year, Augean has turned things around in the past 12 months, delivering EBIT of £ 20million. The balance sheet is clearly the area you need to focus on when analyzing debt. But it is future profits, more than anything, that will determine Augean’s ability to maintain a healthy balance sheet going forward. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. Augean may have net cash on the balance sheet, but it’s always interesting to see how well the company converts its earnings before interest and taxes (EBIT) into free cash flow, as this will influence both its need and its ability to manage debt. Over the past year, Augean has actually generated more free cash flow than EBIT. This kind of cash conversion makes us as excited as the crowd when the beat drops at a Daft Punk concert.
While it always makes sense to look at a company’s total liabilities, it is very reassuring that Augean has £ 6.39million in net cash. The icing on the cake is that he converted 103% of that EBIT into free cash flow, bringing in £ 21million. So we don’t think Augean’s use of debt is risky. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. We have identified 2 warning signs with Augean and understanding them should be part of your investment process.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash net growth stocks.
This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in any of the stocks mentioned.
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