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 seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. We note that Acuity Brands, Inc. (NYSE: AYI) has debt on its balance sheet. But the most important question is: what risk does this debt create?
When is debt a problem?
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. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we think of a business’s use of debt, we first look at cash flow and debt together.
How much debt do Acuity brands carry?
As you can see below, at the end of May 2021, Acuity Brands had $ 498.2 million in debt, up from $ 403.6 million a year ago. Click on the image for more details. But it also has $ 593.5 million in cash to make up for that, which means it has $ 95.3 million in net cash.
NYSE: AYI History of Debt to Equity October 1, 2021
How healthy is the balance sheet for Acuity brands?
Zooming in on the latest balance sheet data, we can see that Acuity Brands had a liability of US $ 671.4 million due within 12 months and a liability of US $ 849.8 million beyond. In compensation for these obligations, he had cash of US $ 593.5 million as well as receivables valued at US $ 509.0 million due within 12 months. Its liabilities therefore total $ 418.7 million more than the combination of its cash and short-term receivables.
Given that Acuity Brands has a market capitalization of US $ 6.12 billion, it is hard to believe that these liabilities pose a significant threat. But there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward. While it has some liabilities to note, Acuity Brands also has more cash than debt, so we’re pretty confident it can handle its debt safely.
Fortunately, Acuity Brands has increased its EBIT by 5.4% over the past year, which makes this debt even more manageable. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Acuity Brands can strengthen its balance sheet over time. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to repay its debts; accounting profits are not enough. Although Acuity Brands has net cash on its balance sheet, it is still worth looking at its ability to convert earnings before interest and taxes (EBIT) into free cash flow, to help us understand how fast it is building. (or erode) this cash balance. Over the past three years, Acuity Brands has recorded free cash flow of 96% of its EBIT, which is higher than what we usually expected. This positions it well to repay debt if it is desirable.
While it’s always a good idea to look at a company’s total liabilities, it’s very reassuring that Acuity Brands has $ 95.3 million in net cash. The icing on the cake was that he converted 96% of that EBIT into free cash flow, bringing in US $ 396 million. So, is Acuity Brands debt a risk? It does not seem to us. On top of most other metrics, we think it’s important to track how quickly earnings per share are growing, if at all. If you have understood this as well, you are in luck because today you can check out this interactive chart of historical earnings per share of Acuity Brands for free.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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