Here's Why Econocom Group (EBR:ECONB) Can Manage Its Debt Responsibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Econocom Group SE (EBR:ECONB) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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 Econocom Group

What Is Econocom Group's Net Debt?

The image below, which you can click on for greater detail, shows that Econocom Group had debt of €552.8m at the end of December 2020, a reduction from €755.8m over a year. But on the other hand it also has €649.3m in cash, leading to a €96.5m net cash position.

How Strong Is Econocom Group's Balance Sheet?

The latest balance sheet data shows that Econocom Group had liabilities of €1.63b due within a year, and liabilities of €555.7m falling due after that. Offsetting these obligations, it had cash of €649.3m as well as receivables valued at €906.7m due within 12 months. So it has liabilities totalling €630.8m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of €688.2m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, Econocom Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

Fortunately, Econocom Group grew its EBIT by 3.9% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Econocom Group 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Econocom Group 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, Econocom Group 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

While Econocom Group does have more liabilities than liquid assets, it also has net cash of €96.5m. And it impressed us with free cash flow of €219m, being 106% of its EBIT. So we don't have any problem with Econocom Group's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Econocom Group 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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