How to assess company debt as a new ASX share investor

Debt gets a bad rap amongst ASX share investors and, to be fair, it’s often deserved. High debt, when taken on for the wrong reasons can sink even quality businesses. But used well, debt can also be a powerful tool.

When considering company debt, look at it from a few angles:

• What is the debt funding?
• How predictable are the cash flows that support it?
• Does management use it as a crutch or a strategic tool?

Debt as a strategy

Debt can be built into a company’s model and used to create leverage. Done well, debt can boost return on equity, manage tax liabilities and build future revenue streams.

There are plenty of examples of this, but the infrastructure assets sector is a good one to look at.

Take ASX share Transurban Group Ltd (ASX:TCL), for example. If you looked its balance sheet alone, debt is high. In FY25, its books showed group debt of $26.8 billion.

But when you step back and investigate, it makes sense. As a toll road provider, Transurban’s projects are usually capital intensive with long delivery time frames and often, predictable demand. Once finished, these projects tend to deliver reliable cash flows, so taking on debt to complete the project is likely a rational move.

Used this way, company debt can create leverage without materially increasing business risk.

Debt as a tool

Debt can also be used as a tool to increase financial flexibility.

Essentially, company debt is used to accelerate growth and adapt with agility when interest rates rise or markets tighten, often via revolving credit facilities (RCFs).

ASX share Goodman Group Ltd (ASX:GMG)  is an example of a company that uses RCFs well. It maintains a strong liquidity buffer ($6.6 billion as at FY25) and keeps gearing relatively low. Usage of credit facilities is intermittent to manage cycles or act on strategic opportunities.

Debt as a crutch

This is the kind of debt investors should be more wary of. Debt can quickly become a liability when a company uses it to fund business as usual.

This type of company debt is more often seen in industries with tight margins and volatile conditions.

Perhaps one of the most cautionary tales from the sector is electronics retailer, Dick Smith. In the lead up to its much-publicised decline, the retailer continued to post relatively healthy revenue, but under the water it was paddling hard. Debt was being used to maintain the appearance of momentum, funding inventory and pulling future sales forward.

High debt isn’t uncommon in retail – and it can be a pathway to turnaround, but it is one that carries significantly higher risk. As was the case for Dick Smith, when consumer demand softens, the company’s balance sheet can’t provide a defence, and the debt can go from manageable to fatal in a matter of weeks.

If debt is tied to short-term earnings and inventory, it’s worth taking a deeper look at what’s happening below the surface.

The bottom line

Of course, a company without debt is much less likely to go under, but in some sectors, particularly capital-intensive ones, debt can be a solid pathway to growth.

The most important question for ASX share investors to ask is how is the debt being used? Is it creating leverage to realise future revenue or providing a crutch to enable continued trading?

If it’s the former, then it’s a functional tool that can deliver positive outcomes for investors. If it’s the latter, it’s a potential red flag and only worth considering if you understand and trust in the levers the company can use to turn things around.

The post How to assess company debt as a new ASX share investor appeared first on The Motley Fool Australia.

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Motley Fool contributor Melissa Maddison has no position in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has positions in and has recommended Goodman Group and Transurban Group. The Motley Fool Australia has positions in and has recommended Transurban Group. The Motley Fool Australia has recommended Goodman Group. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.