These 4 Measures Indicate That EML Payments (ASX:EML) Is Using Debt Extensively

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.' 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. 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?

What Risk Does Debt Bring?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for EML Payments

How Much Debt Does EML Payments Carry?

The image below, which you can click on for greater detail, shows that at December 2021 EML Payments had debt of AU$86.0m, up from AU$36.2m in one year. But it also has AU$86.2m in cash to offset that, meaning it has AU$195.0k net cash.

How Healthy Is EML Payments' Balance Sheet?

We can see from the most recent balance sheet that EML Payments had liabilities of AU$2.18b falling due within a year, and liabilities of AU$148.2m due beyond that. Offsetting this, it had AU$86.2m in cash and AU$63.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$2.17b.

This deficit casts a shadow over the AU$528.4m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, EML Payments would probably need a major re-capitalization if its creditors were to demand repayment. Given that EML Payments has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

Unfortunately, EML Payments's EBIT flopped 19% over the last four quarters. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. 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 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. 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. In the last three years, EML Payments's free cash flow amounted to 36% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While EML Payments does have more liabilities than liquid assets, it also has net cash of AU$195.0k. Unfortunately, though, both its struggle level of total liabilities and its interest cover leave us concerned about EML Payments So despite the cash, we do think it carries some risks. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for EML Payments you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.