Arundel (VTX:ARON) seems to use a lot of debt

Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We note that Arundel SA (VTX:ARON) has debt on its balance sheet. But does this debt worry shareholders?

When is debt a problem?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first step when considering a company’s debt levels is to consider its cash and debt together.

Check out our latest analysis for Arundel

What is Arundel’s debt?

The image below, which you can click for more details, shows that Arundel had $163.3 million in debt at the end of June 2022, a reduction from $175.9 million year-over-year. And he doesn’t have a lot of cash, so his net debt is about the same.

A look at Arundel’s responsibilities

According to the last published balance sheet, Arundel had liabilities of $13.4 million due within 12 months and liabilities of $166.2 million due beyond 12 months. On the other hand, it had liquidities of 3.26 million dollars and 2.78 million dollars of receivables at less than one year. Thus, its liabilities outweigh the sum of its cash and receivables (current) by $173.6 million.

The deficiency here weighs heavily on the $8.22 million business itself, like a child struggling under the weight of a huge backpack full of books, his gym gear and a trumpet. . So we definitely think shareholders need to watch this one closely. After all, Arundel would likely need a major recapitalization if it were to pay its creditors today.

We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). Thus, we consider debt to earnings with and without amortization and depreciation expense.

Arundel shareholders face the double whammy of a high net debt to EBITDA ratio (57.4) and quite low interest coverage, as EBIT is only 0.35 times expenses of interests. This means that we would consider him to be heavily indebted. Fortunately, Arundel has grown its EBIT by 5.7% over the past year, slowly reducing its debt to earnings ratio. There is no doubt that we learn the most about debt from the balance sheet. But you can’t look at debt in total isolation; because Arundel will need income to repay this debt. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.

Finally, while the taxman may love accounting profits, lenders only accept cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Arundel has experienced significant negative free cash flow, in total. While this may be the result of spending for growth, it makes debt much riskier.

Our point of view

To be frank, Arundel’s conversion of EBIT to free cash flow and its track record of keeping its total liabilities in check make us rather uncomfortable with its level of leverage. That said, its ability to grow its EBIT is not such a concern. Considering all the above factors, it seems that Arundel has too much debt. That kind of risk is acceptable to some, but it certainly doesn’t float our boat. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 3 warning signs for Arundel you should know.

Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.