Is Ceconomy (ETR:CEC) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Ceconomy AG (ETR:CEC) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 Ceconomy

What Is Ceconomy's Net Debt?

As you can see below, at the end of June 2020, Ceconomy had €458.0m of debt, up from €434.0m a year ago. Click the image for more detail. But on the other hand it also has €998.0m in cash, leading to a €540.0m net cash position.

A Look At Ceconomy's Liabilities

We can see from the most recent balance sheet that Ceconomy had liabilities of €6.39b falling due within a year, and liabilities of €2.44b due beyond that. On the other hand, it had cash of €998.0m and €1.53b worth of receivables due within a year. So it has liabilities totalling €6.30b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the €1.53b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Ceconomy would likely require a major re-capitalisation if it had to pay its creditors today. 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.

Ceconomy's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Ceconomy'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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. During the last three years, Ceconomy generated free cash flow amounting to a very robust 96% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

Although Ceconomy's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €540.0m. And it impressed us with free cash flow of €515m, being 96% of its EBIT. So we don't have any problem with Ceconomy'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. Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Ceconomy , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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