These 4 Measures Indicate That Amadeus FiRe (ETR:AAD) Is Using Debt Reasonably Well

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Amadeus FiRe AG (ETR:AAD) makes use of debt. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Amadeus FiRe

How Much Debt Does Amadeus FiRe Carry?

As you can see below, at the end of September 2020, Amadeus FiRe had €106.8m of debt, up from none a year ago. Click the image for more detail. On the flip side, it has €26.5m in cash leading to net debt of about €80.3m.

How Healthy Is Amadeus FiRe's Balance Sheet?

We can see from the most recent balance sheet that Amadeus FiRe had liabilities of €173.8m falling due within a year, and liabilities of €56.2m due beyond that. Offsetting this, it had €26.5m in cash and €34.7m in receivables that were due within 12 months. So its liabilities total €168.9m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Amadeus FiRe has a market capitalization of €691.9m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Amadeus FiRe's net debt of 1.8 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 9.3 times interest expense) certainly does not do anything to dispel this impression. Shareholders should be aware that Amadeus FiRe's EBIT was down 33% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Amadeus FiRe's ability to maintain a healthy balance sheet going forward. 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. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Amadeus FiRe recorded free cash flow worth a fulsome 81% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Amadeus FiRe's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its conversion of EBIT to free cash flow. Looking at all this data makes us feel a little cautious about Amadeus FiRe's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - Amadeus FiRe has 4 warning signs we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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