The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, AMMO, Inc. (NASDAQ:POWW) does carry debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is AMMO's Net Debt?
As you can see below, AMMO had US$5.65m of debt at September 2021, down from US$19.4m a year prior. But on the other hand it also has US$32.9m in cash, leading to a US$27.3m net cash position.
How Healthy Is AMMO's Balance Sheet?
According to the last reported balance sheet, AMMO had liabilities of US$43.0m due within 12 months, and liabilities of US$3.26m due beyond 12 months. Offsetting this, it had US$32.9m in cash and US$39.6m in receivables that were due within 12 months. So it can boast US$26.3m more liquid assets than total liabilities.
This short term liquidity is a sign that AMMO could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, AMMO boasts net cash, so it's fair to say it does not have a heavy debt load!
Although AMMO made a loss at the EBIT level, last year, it was also good to see that it generated US$23m in EBIT over the last twelve months. 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 AMMO can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. AMMO 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. Over the last year, AMMO saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
While it is always sensible to investigate a company's debt, in this case AMMO has US$27.3m in net cash and a decent-looking balance sheet. So we don't have any problem with AMMO's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for AMMO (2 are a bit concerning) you should be aware of.
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.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.