Is EML Payments (ASX:EML) A Risky Investment?

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.' 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. We can see that EML Payments Limited (ASX:EML) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for EML Payments

What Is EML Payments's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 EML Payments had AU$36.2m of debt, an increase on none, over one year. But it also has AU$136.5m in cash to offset that, meaning it has AU$100.3m net cash.

A Look At EML Payments' Liabilities

We can see from the most recent balance sheet that EML Payments had liabilities of AU$1.76b falling due within a year, and liabilities of AU$105.7m due beyond that. Offsetting these obligations, it had cash of AU$136.5m as well as receivables valued at AU$45.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$1.68b.

This is a mountain of leverage relative to its market capitalization of AU$1.86b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, EML Payments boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, EML Payments's EBIT fell a jaw-dropping 48% 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 EML Payments 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. EML Payments 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, EML Payments actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

Although EML Payments's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of AU$100.3m. The cherry on top was that in converted 239% of that EBIT to free cash flow, bringing in AU$38m. So although we see some areas for improvement, we're not too worried about EML Payments's balance sheet. 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 be aware of the 1 warning sign we've spotted with EML Payments .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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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