Is Ariadne Australia (ASX:ARA) Using Too Much Debt?

Simply Wall St

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Ariadne Australia Limited (ASX:ARA) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Ariadne Australia

What Is Ariadne Australia's Net Debt?

The image below, which you can click on for greater detail, shows that Ariadne Australia had debt of AU$4.84m at the end of June 2019, a reduction from AU$7.55m over a year. But on the other hand it also has AU$48.1m in cash, leading to a AU$43.2m net cash position.

ASX:ARA Historical Debt, September 20th 2019

A Look At Ariadne Australia's Liabilities

The latest balance sheet data shows that Ariadne Australia had liabilities of AU$5.56m due within a year, and liabilities of AU$267.0k falling due after that. Offsetting these obligations, it had cash of AU$48.1m as well as receivables valued at AU$2.23m due within 12 months. So it can boast AU$44.5m more liquid assets than total liabilities.

This luscious liquidity implies that Ariadne Australia's balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Simply put, the fact that Ariadne Australia has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Ariadne Australia's load is not too heavy, because its EBIT was down 71% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Ariadne Australia's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Ariadne Australia may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Ariadne Australia generated free cash flow amounting to a very robust 85% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Ariadne Australia has net cash of AU$43.2m, as well as more liquid assets than liabilities. The cherry on top was that in converted 85% of that EBIT to free cash flow, bringing in AU$21m. So is Ariadne Australia's debt a risk? It doesn't seem so to us. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Ariadne Australia insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.