Is adesso (ETR:ADN1) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies adesso SE (ETR:ADN1) makes use of debt. But should shareholders be worried about its use of debt?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for adesso

How Much Debt Does adesso Carry?

As you can see below, adesso had €48.6m of debt at December 2020, down from €56.7m a year prior. However, it does have €56.1m in cash offsetting this, leading to net cash of €7.49m.

How Healthy Is adesso's Balance Sheet?

The latest balance sheet data shows that adesso had liabilities of €143.7m due within a year, and liabilities of €125.6m falling due after that. On the other hand, it had cash of €56.1m and €122.7m worth of receivables due within a year. So its liabilities total €90.5m more than the combination of its cash and short-term receivables.

Of course, adesso has a market capitalization of €703.3m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, adesso boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, adesso grew its EBIT by 53% over the last twelve months, and that growth will make it easier to handle its debt. 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 adesso can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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. During the last three years, adesso generated free cash flow amounting to a very robust 87% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While adesso does have more liabilities than liquid assets, it also has net cash of €7.49m. The cherry on top was that in converted 87% of that EBIT to free cash flow, bringing in €54m. So is adesso's debt a risk? It doesn't seem so to us. 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. For instance, we've identified 1 warning sign for adesso that you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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