Here's Why CAP (SNSE:CAP) Can Manage Its Debt Responsibly

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that CAP S.A. (SNSE:CAP) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for CAP

What Is CAP's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 CAP had US$742.4m of debt, an increase on US$700.9m, over one year. But on the other hand it also has US$773.3m in cash, leading to a US$30.9m net cash position.

A Look At CAP's Liabilities

We can see from the most recent balance sheet that CAP had liabilities of US$1.82b falling due within a year, and liabilities of US$1.33b due beyond that. On the other hand, it had cash of US$773.3m and US$608.7m worth of receivables due within a year. So it has liabilities totalling US$1.77b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of US$1.39b, we think shareholders really should watch CAP's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. Given that CAP 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.

Another good sign is that CAP has been able to increase its EBIT by 23% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine CAP's ability to maintain a healthy balance sheet going forward. 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. While CAP 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 two years, CAP recorded free cash flow worth 62% 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

While CAP does have more liabilities than liquid assets, it also has net cash of US$30.9m. And we liked the look of last year's 23% year-on-year EBIT growth. So we are not troubled with CAP's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example CAP has 3 warning signs (and 1 which is potentially serious) we think you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.