Prosegur Cash (BME:CASH) Has A Somewhat Strained Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Prosegur Cash, S.A. (BME:CASH) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Prosegur Cash

What Is Prosegur Cash's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2020 Prosegur Cash had €1.16b of debt, an increase on €963.9m, over one year. On the flip side, it has €494.6m in cash leading to net debt of about €663.9m.

How Healthy Is Prosegur Cash's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Prosegur Cash had liabilities of €681.8m due within 12 months and liabilities of €1.18b due beyond that. Offsetting this, it had €494.6m in cash and €452.7m in receivables that were due within 12 months. So its liabilities total €911.5m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of €1.19b, so it does suggest shareholders should keep an eye on Prosegur Cash's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With a debt to EBITDA ratio of 1.9, Prosegur Cash uses debt artfully but responsibly. And the alluring interest cover (EBIT of 8.4 times interest expense) certainly does not do anything to dispel this impression. One way Prosegur Cash could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 14%, as it did over the last year. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Prosegur Cash's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Prosegur Cash recorded free cash flow of 43% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Even if we have reservations about how easily Prosegur Cash is capable of staying on top of its total liabilities, its interest cover and EBIT growth rate make us think feel relatively unconcerned. Looking at all the angles mentioned above, it does seem to us that Prosegur Cash is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. For example, we've discovered 3 warning signs for Prosegur Cash that you should be aware of before investing here.

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.

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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.
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