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.' 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 note that Dassault Aviation SA (EPA:AM) does have debt on its balance sheet. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is Dassault Aviation's Net Debt?
As you can see below, Dassault Aviation had €123.0m of debt at December 2020, down from €380.9m a year prior. But it also has €3.56b in cash to offset that, meaning it has €3.44b net cash.
A Look At Dassault Aviation's Liabilities
Zooming in on the latest balance sheet data, we can see that Dassault Aviation had liabilities of €8.93b due within 12 months and liabilities of €226.4m due beyond that. Offsetting these obligations, it had cash of €3.56b as well as receivables valued at €1.18b due within 12 months. So it has liabilities totalling €4.40b more than its cash and near-term receivables, combined.
Dassault Aviation has a very large market capitalization of €8.57b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Dassault Aviation boasts net cash, so it's fair to say it does not have a heavy debt load!
It is just as well that Dassault Aviation's load is not too heavy, because its EBIT was down 63% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Dassault Aviation 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 company can only pay off debt with cold hard cash, not accounting profits. While Dassault Aviation 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. Over the last three years, Dassault Aviation recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.
While Dassault Aviation does have more liabilities than liquid assets, it also has net cash of €3.44b. Despite its cash we think that Dassault Aviation seems to struggle to grow its EBIT, so we are wary of the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Dassault Aviation 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.
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