These 4 Measures Indicate That Evotec (ETR:EVT) Is Using Debt Reasonably Well

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 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 note that Evotec SE (ETR:EVT) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Evotec

How Much Debt Does Evotec Carry?

The image below, which you can click on for greater detail, shows that at September 2023 Evotec had debt of €588.7m, up from €327.0m in one year. But on the other hand it also has €613.4m in cash, leading to a €24.6m net cash position.

How Healthy Is Evotec's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Evotec had liabilities of €434.0m due within 12 months and liabilities of €679.6m due beyond that. Offsetting these obligations, it had cash of €613.4m as well as receivables valued at €219.4m due within 12 months. So it has liabilities totalling €281.0m more than its cash and near-term receivables, combined.

Given Evotec has a market capitalization of €2.38b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Evotec boasts net cash, so it's fair to say it does not have a heavy debt load!

Although Evotec made a loss at the EBIT level, last year, it was also good to see that it generated €6.3m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Evotec 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Evotec 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. During the last year, Evotec burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While Evotec does have more liabilities than liquid assets, it also has net cash of €24.6m. So we don't have any problem with Evotec's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Evotec is showing 1 warning sign in our investment analysis , you should know about...

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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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.