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The external fund manager backed by Berkshire Hathaway’s Charlie Munger, Li Lu, makes no bones about it when he says ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a 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, Cogelec SA (EPA:COGEC) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Cogelec Carry?
As you can see below, Cogelec had €7.96m of debt at December 2018, down from €11.3m a year prior. However, its balance sheet shows it holds €16.4m in cash, so it actually has €8.44m net cash.
How Healthy Is Cogelec’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Cogelec had liabilities of €10.5m due within 12 months and liabilities of €23.5m due beyond that. Offsetting these obligations, it had cash of €16.4m as well as receivables valued at €11.0m due within 12 months. So its liabilities total €6.53m more than the combination of its cash and short-term receivables.
Of course, Cogelec has a market capitalization of €68.3m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Given that Cogelec has more cash than debt, we’re pretty confident it can manage its debt safely.
Importantly, Cogelec’s EBIT fell a jaw-dropping 73% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There’s no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Cogelec can strengthen its balance sheet over time. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Cogelec 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. Looking at the most recent three years, Cogelec recorded free cash flow of 38% of its EBIT, which is weaker than we’d expect. That weak cash conversion makes it more difficult to handle indebtedness.
While it is always sensible to look at a company’s total liabilities, it is very reassuring that Cogelec has €8.4m in net cash. So while Cogelec does not have a great balance sheet, it’s certainly not too bad. While Cogelec didn’t make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away.Click here to see if its earnings are heading in the right direction, over the medium term.
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.