Warren Buffett famously said, ‘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 note that AMMO, Inc. (NASDAQ:POWW) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
Our analysis indicates that POWW is potentially undervalued!
What Is AMMO’s Debt?
As you can see below, at the end of September 2022, AMMO had US$12.9m of debt, up from US$5.65m a year ago. Click the image for more detail. But it also has US$29.0m in cash to offset that, meaning it has US$16.1m net cash.
A Look At AMMO’s Liabilities
The latest balance sheet data shows that AMMO had liabilities of US$31.9m due within a year, and liabilities of US$14.8m falling due after that. Offsetting these obligations, it had cash of US$29.0m as well as receivables valued at US$30.4m due within 12 months. So it actually has US$12.7m more liquid assets than total liabilities.
This surplus suggests that AMMO has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, AMMO boasts net cash, so it’s fair to say it does not have a heavy debt load!
In fact AMMO’s saving grace is its low debt levels, because its EBIT has tanked 23% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine AMMO’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While AMMO has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last two years, AMMO burned a lot of cash. 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$16.1m in net cash and a decent-looking balance sheet. So although we see some areas for improvement, we’re not too worried about AMMO’s balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it. For instance, we’ve identified 2 warning signs for AMMO that you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
What are the risks and opportunities for AMMO?
Trading at 25.9% below our estimate of its fair value
Earnings are forecast to grow 98.69% per year
Shareholders have been diluted in the past year
Profit margins (3.9%) are lower than last year (14.7%)
View all Risks and Rewards
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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.