We Think Etex (EBR:094124453) Can Stay On Top Of Its Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 note that Etex N.V. (EBR:094124453) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Etex

What Is Etex's Debt?

The image below, which you can click on for greater detail, shows that Etex had debt of €321.8m at the end of December 2020, a reduction from €418.8m over a year. However, it does have €414.3m in cash offsetting this, leading to net cash of €92.5m.

How Strong Is Etex's Balance Sheet?

The latest balance sheet data shows that Etex had liabilities of €903.9m due within a year, and liabilities of €794.1m falling due after that. Offsetting this, it had €414.3m in cash and €272.4m in receivables that were due within 12 months. So its liabilities total €1.01b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of €1.36b, so it does suggest shareholders should keep an eye on Etex's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, Etex boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Etex has increased its EBIT by 6.8% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Etex will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Etex 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. Over the most recent three years, Etex recorded free cash flow worth 69% 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.

Summing up

Although Etex's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €92.5m. The cherry on top was that in converted 69% of that EBIT to free cash flow, bringing in €329m. So we don't have any problem with Etex's use of debt. 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 - Etex has 1 warning sign we think you should be aware of.

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. 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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