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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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Austal Limited (ASX:ASB) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for Austal
What Is Austal's Debt?
As you can see below, Austal had AU$118.1m of debt at December 2021, down from AU$148.3m a year prior. But it also has AU$306.8m in cash to offset that, meaning it has AU$188.7m net cash.
How Healthy Is Austal's Balance Sheet?
We can see from the most recent balance sheet that Austal had liabilities of AU$307.1m falling due within a year, and liabilities of AU$364.4m due beyond that. Offsetting this, it had AU$306.8m in cash and AU$41.0m in receivables that were due within 12 months. So its liabilities total AU$323.7m more than the combination of its cash and short-term receivables.
Austal has a market capitalization of AU$728.5m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Austal boasts net cash, so it's fair to say it does not have a heavy debt load!
The modesty of its debt load may become crucial for Austal if management cannot prevent a repeat of the 23% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Austal's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.