Does Aurionpro Solutions (NSE: AURIONPRO) use too much debt?
Legendary fund manager Li Lu (whom Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. So it can be obvious that you need to consider debt, when you think about how risky a given stock is, because too much debt can sink a business. Like many other companies Aurionpro Solutions Limited (NSE: AURIONPRO) uses debt. But does this debt worry shareholders?
When is debt dangerous?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. If things really go wrong, lenders can take over the business. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we think of a business’s use of debt, we first look at cash flow and debt together.
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What is Aurionpro Solutions’ debt?
You can click on the graph below for historical figures, but it shows that Aurionpro Solutions had 616.7 million yen in debt in September 2021, up from 1.04 billion yen a year earlier. However, given that it has a cash reserve of 303.3 million, its net debt is less, at around 313.4 million.
Is Aurionpro Solutions’ balance sheet healthy?
We can see from the most recent balance sheet that Aurionpro Solutions had liabilities of 1.79 billion yen due within one year and liabilities of 532.3 million yen due beyond. On the other hand, he had 303.3 million yen in cash and receivables worth 1.18 billion yen within a year. She therefore has a liability totaling 843.4 million yen more than her cash and short-term receivables combined.
Considering that Aurionpro Solutions has a market cap of 5.31b, it is hard to believe that these liabilities pose a significant threat. However, we think it’s worth keeping an eye on the strength of its balance sheet as it can change over time.
We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). Thus, we consider debt versus earnings with and without amortization charges.
With net debt of just 0.43 times EBITDA, Aurionpro Solutions is arguably fairly cautious. And this view is underpinned by the strong interest coverage, with EBIT reaching 8.6 times the interest expense of last year. On top of that, Aurionpro Solutions has increased its EBIT by 68% over the past twelve months, and this growth will make it easier to process its debt. There is no doubt that we learn the most about debt from the balance sheet. But you can’t look at debt in isolation; since Aurionpro Solutions will need income to repay this debt. So if you want to know more about its profits, it may be worth checking out this chart of its long term profit trend.
Finally, a business can only pay off its debts with hard cash, not with book profits. We therefore always check how much of this EBIT is converted into free cash flow. During the last three years, Aurionpro Solutions has created a free cash flow of 3.0% of its EBIT, a performance without interest. This low level of cash conversion undermines its ability to manage and repay its debts.
Our point of view
Fortunately, Aurionpro Solutions’ impressive EBIT growth rate means that it has the upper hand over its debt. But we have to admit that its conversion from EBIT to free cash flow has the opposite effect. All these things considered, it looks like Aurionpro Solutions can comfortably manage its current level of debt. On the plus side, this leverage can increase returns to shareholders, but the potential downside is more risk of loss, so it’s worth watching the balance sheet. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. To this end, you should inquire about the 2 warning signs we spotted with Aurionpro Solutions (including 1 which is significant).
At the end of the day, it’s often best to focus on businesses with no net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.
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