Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘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. Importantly, ADLPartner SA (EPA:DKUPL) does carry debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.
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What Is ADLPartner’s Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2023 ADLPartner had €46.8m of debt, an increase on €27.0m, over one year. However, its balance sheet shows it holds €58.6m in cash, so it actually has €11.8m net cash.
A Look At ADLPartner’s Liabilities
According to the last reported balance sheet, ADLPartner had liabilities of €83.2m due within 12 months, and liabilities of €57.8m due beyond 12 months. Offsetting this, it had €58.6m in cash and €51.8m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €30.6m.
This deficit isn’t so bad because ADLPartner is worth €98.8m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, ADLPartner boasts net cash, so it’s fair to say it does not have a heavy debt load!
On the other hand, ADLPartner’s EBIT dived 18%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if ADLPartner can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. ADLPartner may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, ADLPartner recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we’d usually expect. That puts it in a very strong position to pay down debt.
While ADLPartner does have more liabilities than liquid assets, it also has net cash of €11.8m. And it impressed us with free cash flow of €20m, being 84% of its EBIT. So we don’t have any problem with ADLPartner’s use of debt. 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. Case in point: We’ve spotted 1 warning sign for ADLPartner 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.
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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.