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. It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Eurotech S.p.A. (BIT:ETH) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is Eurotech’s Net Debt?
The image below, which you can click on for greater detail, shows that Eurotech had debt of €11.6m at the end of March 2020, a reduction from €13.6m over a year. However, its balance sheet shows it holds €27.9m in cash, so it actually has €16.2m net cash.
How Healthy Is Eurotech’s Balance Sheet?
The latest balance sheet data shows that Eurotech had liabilities of €25.8m due within a year, and liabilities of €16.9m falling due after that. Offsetting this, it had €27.9m in cash and €13.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €1.46m.
This state of affairs indicates that Eurotech’s balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it’s very unlikely that the €212.0m company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Eurotech also has more cash than debt, so we’re pretty confident it can manage its debt safely.
On top of that, Eurotech grew its EBIT by 77% 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 Eurotech’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 business needs free cash flow to pay off debt; accounting profits just don’t cut it. Eurotech 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 most recent three years, Eurotech recorded free cash flow worth 77% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
While it is always sensible to look at a company’s total liabilities, it is very reassuring that Eurotech has €16.2m in net cash. And we liked the look of last year’s 77% year-on-year EBIT growth. So we don’t think Eurotech’s use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we’ve spotted with Eurotech (including 1 which is doesn’t sit too well with us) .
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. 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. Thank you for reading.