We Think Audax Renovables (BME:ADX) Is Taking Some Risk With Its Debt

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.' 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. We note that Audax Renovables, S.A. (BME:ADX) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Audax Renovables

What Is Audax Renovables's Debt?

As you can see below, Audax Renovables had €617.6m of debt at June 2023, down from €762.4m a year prior. However, because it has a cash reserve of €284.1m, its net debt is less, at about €333.5m.

How Strong Is Audax Renovables' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Audax Renovables had liabilities of €558.8m due within 12 months and liabilities of €560.7m due beyond that. Offsetting this, it had €284.1m in cash and €313.1m in receivables that were due within 12 months. So it has liabilities totalling €522.4m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of €532.7m, so it does suggest shareholders should keep an eye on Audax Renovables' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). 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).

While we wouldn't worry about Audax Renovables's net debt to EBITDA ratio of 4.4, we think its super-low interest cover of 2.0 times is a sign of high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. The good news is that Audax Renovables grew its EBIT a smooth 45% over the last twelve months. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. 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 Audax Renovables's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Audax Renovables created free cash flow amounting to 15% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

On the face of it, Audax Renovables's net debt to EBITDA left us tentative about the stock, and its interest cover was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its EBIT growth rate 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 Audax Renovables stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - Audax Renovables has 1 warning sign we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.