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 can see that Somfy SA (EPA:SO) does use debt in its business. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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 step when considering a company's debt levels is to consider its cash and debt together.
What Is Somfy's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2022 Somfy had €41.9m of debt, an increase on €39.6m, over one year. But it also has €683.9m in cash to offset that, meaning it has €642.0m net cash.
How Strong Is Somfy's Balance Sheet?
The latest balance sheet data shows that Somfy had liabilities of €340.9m due within a year, and liabilities of €127.7m falling due after that. Offsetting these obligations, it had cash of €683.9m as well as receivables valued at €261.3m due within 12 months. So it actually has €476.6m more liquid assets than total liabilities.
This short term liquidity is a sign that Somfy could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Somfy has more cash than debt is arguably a good indication that it can manage its debt safely.
In fact Somfy's saving grace is its low debt levels, because its EBIT has tanked 24% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Somfy'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Somfy may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Somfy generated free cash flow amounting to a very robust 81% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Somfy has net cash of €642.0m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of €166m, being 81% of its EBIT. So we don't have any problem with Somfy's use of debt. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Somfy's earnings per share history for free.
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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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.
Somfy SA manufactures and sells automatic controls for openings and closures in homes and buildings.
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