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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. As with many other companies AEI Corporation Ltd. (SGX:AWG) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.
See our latest analysis for AEI
What Is AEI's Net Debt?
You can click the graphic below for the historical numbers, but it shows that AEI had S$2.56m of debt in June 2019, down from S$2.93m, one year before. However, it does have S$36.9m in cash offsetting this, leading to net cash of S$34.4m.
How Strong Is AEI's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that AEI had liabilities of S$3.72m due within 12 months and liabilities of S$10.0m due beyond that. On the other hand, it had cash of S$36.9m and S$2.11m worth of receivables due within a year. So it can boast S$25.3m more liquid assets than total liabilities.
This surplus liquidity suggests that AEI's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. Succinctly put, AEI boasts net cash, so it's fair to say it does not have a heavy debt load!
Although AEI made a loss at the EBIT level, last year, it was also good to see that it generated S$3.9m in EBIT over the last twelve months. 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 AEI will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While AEI 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. During the last year, AEI burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.