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.' 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 A.S. Création Tapeten AG (ETR:ACWN) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
What Is A.S. Création Tapeten's Net Debt?
The image below, which you can click on for greater detail, shows that A.S. Création Tapeten had debt of €9.63m at the end of June 2021, a reduction from €12.4m over a year. However, it does have €20.9m in cash offsetting this, leading to net cash of €11.2m.
A Look At A.S. Création Tapeten's Liabilities
The latest balance sheet data shows that A.S. Création Tapeten had liabilities of €28.1m due within a year, and liabilities of €22.2m falling due after that. Offsetting this, it had €20.9m in cash and €27.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €1.90m.
Since publicly traded A.S. Création Tapeten shares are worth a total of €56.2m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, A.S. Création Tapeten boasts net cash, so it's fair to say it does not have a heavy debt load!
Better yet, A.S. Création Tapeten grew its EBIT by 6,569% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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 A.S. Création Tapeten can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. A.S. Création Tapeten 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. Considering the last three years, A.S. Création Tapeten actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
While it is always sensible to look at a company's total liabilities, it is very reassuring that A.S. Création Tapeten has €11.2m in net cash. And it impressed us with its EBIT growth of 6,569% over the last year. So we don't have any problem with A.S. Création Tapeten's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - A.S. Création Tapeten has 3 warning signs we think you should be aware of.
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.
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.
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