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. As with many other companies Precia SA (EPA:PREC) makes use of debt. But the real question is whether this debt is making the company risky.
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for Precia
How Much Debt Does Precia Carry?
As you can see below, Precia had €17.0m of debt, at June 2019, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has €31.1m in cash, leading to a €14.2m net cash position.
How Strong Is Precia's Balance Sheet?
According to the last reported balance sheet, Precia had liabilities of €49.2m due within 12 months, and liabilities of €18.6m due beyond 12 months. On the other hand, it had cash of €31.1m and €36.0m worth of receivables due within a year. So these liquid assets roughly match the total liabilities.
Having regard to Precia's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the €91.9m company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Precia also has more cash than debt, so we're pretty confident it can manage its debt safely.
The good news is that Precia has increased its EBIT by 6.1% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Precia will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Precia 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. Looking at the most recent three years, Precia recorded free cash flow of 26% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
Summing up
We could understand if investors are concerned about Precia's liabilities, but we can be reassured by the fact it has has net cash of €14.2m. And it also grew its EBIT by 6.1% over the last year. So we are not troubled with Precia's debt use. 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. To that end, you should be aware of the 2 warning signs we've spotted with Precia .
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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