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 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. As with many other companies Ceconomy AG (ETR:CEC) makes use of debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. 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. 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.
How Much Debt Does Ceconomy Carry?
You can click the graphic below for the historical numbers, but it shows that Ceconomy had €343.0m of debt in March 2021, down from €1.53b, one year before. But it also has €998.0m in cash to offset that, meaning it has €655.0m net cash.
How Strong Is Ceconomy's Balance Sheet?
According to the last reported balance sheet, Ceconomy had liabilities of €7.10b due within 12 months, and liabilities of €2.16b due beyond 12 months. Offsetting this, it had €998.0m in cash and €1.61b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €6.66b.
The deficiency here weighs heavily on the €1.42b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Ceconomy would probably need a major re-capitalization if its creditors were to demand repayment. Ceconomy boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.
Also positive, Ceconomy grew its EBIT by 21% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Ceconomy 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. While Ceconomy 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. Happily for any shareholders, Ceconomy actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
While Ceconomy does have more liabilities than liquid assets, it also has net cash of €655.0m. And it impressed us with free cash flow of €314m, being 141% of its EBIT. So we don't have any problem with Ceconomy'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. For example, we've discovered 2 warning signs for Ceconomy that you should be aware of before investing here.
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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