David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Mostly, Avnet, Inc. (NASDAQ:AVT) is in debt. But the real question is whether this debt makes the business risky.
What risk does debt carry?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, many companies use debt to finance their growth, without any negative consequences. When we look at debt levels, we first consider cash and debt levels, together.
Check out our latest analysis for Avnet
What is Avnet’s debt?
As you can see below, at the end of January 2022, Avnet had $1.49 billion in debt, up from $1.21 billion a year ago. Click on the image for more details. However, he has $167.8 million in cash to offset this, resulting in a net debt of approximately $1.33 billion.
How strong is Avnet’s balance sheet?
We can see from the most recent balance sheet that Avnet had liabilities of US$3.69 billion maturing in one year, and liabilities of US$1.69 billion due beyond. In compensation for these obligations, it had cash of 167.8 million US dollars as well as receivables valued at 4.08 billion US dollars maturing within 12 months. It therefore has liabilities totaling $1.13 billion more than its cash and short-term receivables, combined.
Avnet has a market capitalization of US$4.18 billion, so it could very likely raise funds to improve its balance sheet, should the need arise. But we definitely want to keep our eyes peeled for indications that its debt is too risky.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). Thus, we consider debt to earnings with and without depreciation and amortization charges.
With a debt to EBITDA ratio of 1.7, Avnet uses debt wisely but responsibly. And the attractive interest cover (EBIT of 7.2 times interest expense) certainly makes do not do everything to dispel this impression. Fortunately, Avnet is growing its EBIT faster than former Australian Prime Minister Bob Hawke dropped a yard glass, with a 227% gain over the last twelve months. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Avnet 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, while the taxman may love accounting profits, lenders only accept cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Avnet has recorded free cash flow of 78% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
Avnet’s EBIT growth rate suggests it can manage its debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. And this is only the beginning of good news since its conversion of EBIT into free cash flow is also very pleasing. Zooming out, Avnet seems to be using debt quite sensibly; and that gets the green light from us. Although debt carries risks, when used wisely, it can also generate a higher return on equity. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we have identified 3 warning signs for Avnet (1 is concerning) that you should be aware of.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.