Is adesso (ETR:ADN1) A Risky Investment?

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 adesso SE (ETR:ADN1) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for adesso

How Much Debt Does adesso Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 adesso had €78.9m of debt, an increase on €60.7m, over one year. But it also has €110.1m in cash to offset that, meaning it has €31.2m net cash.

A Look At adesso's Liabilities

Zooming in on the latest balance sheet data, we can see that adesso had liabilities of €179.3m due within 12 months and liabilities of €184.6m due beyond that. Offsetting these obligations, it had cash of €110.1m as well as receivables valued at €170.3m due within 12 months. So its liabilities total €83.5m more than the combination of its cash and short-term receivables.

Of course, adesso has a market capitalization of €1.02b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, adesso also has more cash than debt, so we're pretty confident it can manage its debt safely.

Also positive, adesso grew its EBIT by 29% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine adesso's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. adesso 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. Over the last three years, adesso recorded free cash flow worth a fulsome 85% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that adesso has €31.2m in net cash. And it impressed us with free cash flow of €30m, being 85% of its EBIT. So is adesso's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - adesso has 3 warning signs we think you should be aware of.

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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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.