February 5, 2023

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, The a2 Milk Company Limited (NZSE:ATM) does carry debt. But the real question is whether this debt is making the company risky.
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for a2 Milk
The image below, which you can click on for greater detail, shows that at June 2022 a2 Milk had debt of NZ$107.0m, up from none in one year. However, it does have NZ$887.3m in cash offsetting this, leading to net cash of NZ$780.3m.
We can see from the most recent balance sheet that a2 Milk had liabilities of NZ$440.2m falling due within a year, and liabilities of NZ$81.7m due beyond that. On the other hand, it had cash of NZ$887.3m and NZ$89.4m worth of receivables due within a year. So it can boast NZ$454.8m more liquid assets than total liabilities.
This surplus suggests that a2 Milk has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that a2 Milk has more cash than debt is arguably a good indication that it can manage its debt safely.
On top of that, a2 Milk grew its EBIT by 40% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine a2 Milk's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While a2 Milk 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 three years, a2 Milk generated free cash flow amounting to a very robust 82% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
While we empathize with investors who find debt concerning, you should keep in mind that a2 Milk has net cash of NZ$780.3m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NZ$199m, being 82% of its EBIT. So we don't think a2 Milk's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for a2 Milk that you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.
Find out whether a2 Milk is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.
Simply Wall St's Editorial Team provides unbiased, factual reporting on global stocks using in-depth fundamental analysis.
Find out more about our editorial guidelines and team.
The a2 Milk Company Limited, together with its subsidiaries, sells A2 protein type branded milk and related products in Australia, New Zealand, China, other Asian countries, and the United States.
The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.
Read more about these checks in the individual report sections or in our analysis model.
Excellent balance sheet with proven track record.
Simply Wall St's Editorial Team provides unbiased, factual reporting on global stocks using in-depth fundamental analysis.
Find out more about our editorial guidelines and team.
The a2 Milk Company Limited, together with its subsidiaries, sells A2 protein type branded milk and related products in Australia, New Zealand, China, other Asian countries, and the United States.
The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.
Read more about these checks in the individual report sections or in our analysis model.
Excellent balance sheet with proven track record.
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