Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Prosegur Cash, S.A. (BME:CASH) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. If things get really bad, the lenders can take control of the business. 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.
What Is Prosegur Cash's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 Prosegur Cash had €1.14b of debt, an increase on €850.4m, over one year. On the flip side, it has €505.7m in cash leading to net debt of about €635.1m.
A Look At Prosegur Cash's Liabilities
According to the last reported balance sheet, Prosegur Cash had liabilities of €569.8m due within 12 months, and liabilities of €1.20b due beyond 12 months. Offsetting this, it had €505.7m in cash and €381.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €885.3m.
This deficit is considerable relative to its market capitalization of €1.28b, so it does suggest shareholders should keep an eye on Prosegur Cash's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
With a debt to EBITDA ratio of 2.3, Prosegur Cash uses debt artfully but responsibly. And the fact that its trailing twelve months of EBIT was 7.1 times its interest expenses harmonizes with that theme. Importantly, Prosegur Cash's EBIT fell a jaw-dropping 32% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Prosegur Cash'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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Prosegur Cash produced sturdy free cash flow equating to 58% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
We'd go so far as to say Prosegur Cash's EBIT growth rate was disappointing. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Prosegur Cash stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Prosegur Cash 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.
If you decide to trade Prosegur Cash, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account.
This article by Simply Wall St is general in nature. 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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.