Is Azkoyen (BME:AZK) A Risky Investment?

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. Importantly, Azkoyen, S.A. (BME:AZK) does carry 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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Azkoyen

What Is Azkoyen's Net Debt?

The image below, which you can click on for greater detail, shows that Azkoyen had debt of €16.3m at the end of December 2020, a reduction from €17.5m over a year. However, its balance sheet shows it holds €21.1m in cash, so it actually has €4.76m net cash.

How Strong Is Azkoyen's Balance Sheet?

We can see from the most recent balance sheet that Azkoyen had liabilities of €34.2m falling due within a year, and liabilities of €20.3m due beyond that. Offsetting this, it had €21.1m in cash and €28.2m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €5.24m.

Given Azkoyen has a market capitalization of €141.9m, 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. While it does have liabilities worth noting, Azkoyen also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for Azkoyen if management cannot prevent a repeat of the 48% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Azkoyen will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Azkoyen 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, Azkoyen generated free cash flow amounting to a very robust 82% of its EBIT, more than we'd 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 Azkoyen has €4.76m in net cash. And it impressed us with free cash flow of €9.7m, being 82% of its EBIT. So we are not troubled with Azkoyen's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Azkoyen .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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