Here's Why Atresmedia Corporación de Medios de Comunicación (BME:A3M) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We can see that Atresmedia Corporación de Medios de Comunicación, S.A. (BME:A3M) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Atresmedia Corporación de Medios de Comunicación

What Is Atresmedia Corporación de Medios de Comunicación's Net Debt?

The image below, which you can click on for greater detail, shows that Atresmedia Corporación de Medios de Comunicación had debt of €265.7m at the end of June 2021, a reduction from €373.7m over a year. On the flip side, it has €228.5m in cash leading to net debt of about €37.1m.

A Look At Atresmedia Corporación de Medios de Comunicación's Liabilities

We can see from the most recent balance sheet that Atresmedia Corporación de Medios de Comunicación had liabilities of €435.2m falling due within a year, and liabilities of €381.7m due beyond that. On the other hand, it had cash of €228.5m and €262.3m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €326.0m.

This deficit isn't so bad because Atresmedia Corporación de Medios de Comunicación is worth €775.5m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Atresmedia Corporación de Medios de Comunicación's net debt is only 0.32 times its EBITDA. And its EBIT easily covers its interest expense, being 31.1 times the size. So we're pretty relaxed about its super-conservative use of debt. Atresmedia Corporación de Medios de Comunicación's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Atresmedia Corporación de Medios de Comunicación can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Atresmedia Corporación de Medios de Comunicación recorded free cash flow worth a fulsome 91% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

The good news is that Atresmedia Corporación de Medios de Comunicación's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. When we consider the range of factors above, it looks like Atresmedia Corporación de Medios de Comunicación is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Atresmedia Corporación de Medios de Comunicación .

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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