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 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. We note that Astronics Corporation (NASDAQ:ATRO) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we think about a company’s use of debt, we first look at cash and debt together.

What Is Astronics’s Net Debt?

As you can see below, at the end of October 2021, Astronics had US$183.0m of debt, up from US$168.2m a year ago. Click the image for more detail. However, because it has a cash reserve of US$29.1m, its net debt is less, at about US$153.9m.

A Look At Astronics’ Liabilities

According to the last reported balance sheet, Astronics had liabilities of US$101.8m due within 12 months, and liabilities of US$256.8m due beyond 12 months. Offsetting this, it had US$29.1m in cash and US$115.1m in receivables that were due within 12 months. So it has liabilities totalling US$214.5m more than its cash and near-term receivables, combined.

This deficit isn’t so bad because Astronics is worth US$363.3m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it’s clear that we should definitely closely examine whether it can manage its debt without dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Astronics can strengthen its balance sheet over time.

Over 12 months, Astronics made a loss at the EBIT level, and saw its revenue drop to US$444m, which is a fall of 24%. To be frank that doesn’t bode well.

Caveat Emptor

While Astronics’s falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at US$31m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled US$19m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. There’s no doubt that we learn most about debt from the balance sheet.