AeroVironment (NASDAQ: AVAV) could easily take on more debt
Legendary fund manager Li Lu (whom Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the fact that you suffer a permanent loss of capital. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We can see that AeroVironment, Inc. (NASDAQ: AVAV) uses debt in its business. But the real question is whether this debt makes the business risky.
Why Does Debt Bring Risk?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. 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. Of course, many companies use debt to finance their growth without negative consequences. When we look at debt levels, we first consider both liquidity and debt levels.
Check out our latest analysis for AeroVironment
What is AeroVironment’s net debt?
The image below, which you can click for more details, shows that as of April 2021, AeroVironment was in debt of $ 197.5 million, up from none in a year. However, it has $ 180.7 million in cash offsetting that, which leads to net debt of around $ 16.8 million.
How healthy is AeroVironment’s track record?
Zooming in on the latest balance sheet data, we can see that AeroVironment had liabilities of US $ 96.2 million due within 12 months and liabilities of US $ 220.3 million due beyond. On the other hand, he had cash of US $ 180.7 million and US $ 134.3 million in receivables within one year. These liquid assets therefore correspond roughly to the total liabilities.
Considering the size of AeroVironment, it appears that its liquid assets are well balanced with its total liabilities. So while it’s hard to imagine the US $ 2.32 billion company struggling to get cash, we still think it’s worth watching its balance sheet. But in any case, AeroVironment has virtually no net debt, so it’s fair to say that it doesn’t have heavy debt!
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt over EBITDA) and the actual interest charges associated with this debt (with its interest coverage rate). ).
AeroVironment has a low net debt to EBITDA ratio of just 0.24. And its EBIT covers its interest costs a whopping 81.4 times. So we’re pretty relaxed about its ultra-conservative use of debt. The good news is that AeroVironment increased its EBIT by 8.6% year over year, which should allay concerns about debt repayment. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether AeroVironment 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 IRS may love accounting profits, lenders only accept hard cash. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. Over the past three years, AeroVironment has generated strong free cash flow equivalent to 74% of its EBIT, roughly what we expected. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
AeroVironment’s interest coverage suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. And this is only the beginning of the good news since its net debt to EBITDA is also very encouraging. Zooming out, AeroVironment seems to be using the debt in a very reasonable way; and that gets the nod from us. After all, reasonable leverage can increase returns on equity. The balance sheet is clearly the area you need to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. To do this, you need to know the 3 warning signs we spotted with AeroVironment.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.
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