Does Applus Services (BME:APPS) Have A Healthy Balance Sheet?

Warren Buffett famously said, '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. Importantly, Applus Services, S.A. (BME:APPS) does carry debt. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

View our latest analysis for Applus Services

How Much Debt Does Applus Services Carry?

As you can see below, Applus Services had €734.6m of debt, at June 2021, which is about the same as the year before. You can click the chart for greater detail. However, it does have €156.5m in cash offsetting this, leading to net debt of about €578.1m.

A Look At Applus Services' Liabilities

According to the last reported balance sheet, Applus Services had liabilities of €500.0m due within 12 months, and liabilities of €1.07b due beyond 12 months. On the other hand, it had cash of €156.5m and €380.7m worth of receivables due within a year. So its liabilities total €1.03b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of €1.09b, so it does suggest shareholders should keep an eye on Applus Services' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Applus Services's net debt to EBITDA ratio of about 1.6 suggests only moderate use of debt. And its commanding EBIT of 13.9 times its interest expense, implies the debt load is as light as a peacock feather. Even more impressive was the fact that Applus Services grew its EBIT by 306% over twelve months. That boost will make it even easier to pay down debt going forward. 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 Applus Services 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Applus Services 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.

Our View

The good news is that Applus Services's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its level of total liabilities. Taking all this data into account, it seems to us that Applus Services takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. We've identified 3 warning signs with Applus Services , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.