Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ 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 Advanced Emissions Solutions, Inc. (NASDAQ:ADES) makes use of debt. But the more important question is: how much risk is that debt creating?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.
What Is Advanced Emissions Solutions’s Debt?
The image below, which you can click on for greater detail, shows that Advanced Emissions Solutions had debt of US$8.95m at the end of March 2021, a reduction from US$32.0m over a year. However, its balance sheet shows it holds US$42.2m in cash, so it actually has US$33.3m net cash.
A Look At Advanced Emissions Solutions’ Liabilities
The latest balance sheet data shows that Advanced Emissions Solutions had liabilities of US$34.9m due within a year, and liabilities of US$17.5m falling due after that. On the other hand, it had cash of US$42.2m and US$14.4m worth of receivables due within a year. So it actually has US$4.23m more liquid assets than total liabilities.
This short term liquidity is a sign that Advanced Emissions Solutions could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Advanced Emissions Solutions has more cash than debt is arguably a good indication that it can manage its debt safely. 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 Advanced Emissions Solutions will need earnings to service that debt.
Over 12 months, Advanced Emissions Solutions reported revenue of US$70m, which is a gain of 12%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.
So How Risky Is Advanced Emissions Solutions?
Although Advanced Emissions Solutions had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of US$55m. So taking that on face value, and considering the net cash situation, we don’t think that the stock is too risky in the near term. With mediocre revenue growth in the last year, we’re don’t find the investment opportunity particularly compelling. The balance sheet is clearly the area to focus on when you are analysing debt.
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