Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Ascent Industries Co. (NASDAQ:ACNT) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. When we think about a company’s use of debt, we first look at cash and debt together.
What Is Ascent Industries’s Net Debt?
The chart below, which you can click on for greater detail, shows that Ascent Industries had US$71.9m in debt in December 2022; about the same as the year before. However, because it has a cash reserve of US$1.44m, its net debt is less, at about US$70.5m.
A Look At Ascent Industries’ Liabilities
Zooming in on the latest balance sheet data, we can see that Ascent Industries had liabilities of US$33.5m due within 12 months and liabilities of US$101.3m due beyond that. Offsetting these obligations, it had cash of US$1.44m as well as receivables valued at US$45.1m due within 12 months. So its liabilities total US$88.2m more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of US$100.4m, so it does suggest shareholders should keep an eye on Ascent Industries’ use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
With a debt to EBITDA ratio of 2.1, Ascent Industries uses debt artfully but responsibly. And the fact that its trailing twelve months of EBIT was 7.9 times its interest expenses harmonizes with that theme. Shareholders should be aware that Ascent Industries’s EBIT was down 30% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Ascent Industries’s earnings that will influence how the balance sheet holds up in the future.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last two years, Ascent Industries’s free cash flow amounted to 35% of its EBIT, less than we’d expect. That weak cash conversion makes it more difficult to handle indebtedness.
Our View
We’d go so far as to say Ascent Industries’s EBIT growth rate was disappointing. But at least it’s pretty decent at covering its interest expense with its EBIT; that’s encouraging. Overall, we think it’s fair to say that Ascent Industries has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses.