We Think Lexibook - Linguistic Electronic System Société anonyme (EPA:ALLEX) Is Taking Some Risk With Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Lexibook - Linguistic Electronic System Société anonyme (EPA:ALLEX) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 Lexibook - Linguistic Electronic System Société anonyme

How Much Debt Does Lexibook - Linguistic Electronic System Société anonyme Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Lexibook - Linguistic Electronic System Société anonyme had €10.0m of debt, an increase on €9.12m, over one year. However, it also had €886.4k in cash, and so its net debt is €9.16m.

How Strong Is Lexibook - Linguistic Electronic System Société anonyme's Balance Sheet?

The latest balance sheet data shows that Lexibook - Linguistic Electronic System Société anonyme had liabilities of €12.8m due within a year, and liabilities of €5.15m falling due after that. Offsetting these obligations, it had cash of €886.4k as well as receivables valued at €6.98m due within 12 months. So it has liabilities totalling €10.1m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of €13.0m, so it does suggest shareholders should keep an eye on Lexibook - Linguistic Electronic System Société anonyme's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Lexibook - Linguistic Electronic System Société anonyme shareholders face the double whammy of a high net debt to EBITDA ratio (11.5), and fairly weak interest coverage, since EBIT is just 0.77 times the interest expense. The debt burden here is substantial. The silver lining is that Lexibook - Linguistic Electronic System Société anonyme grew its EBIT by 265% last year, which nourishing like the idealism of youth. If it can keep walking that path it will be in a position to shed its debt with relative ease. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Lexibook - Linguistic Electronic System Société anonyme's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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 two years, Lexibook - Linguistic Electronic System Société anonyme saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Lexibook - Linguistic Electronic System Société anonyme's interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow 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 bigger picture, it seems clear to us that Lexibook - Linguistic Electronic System Société anonyme's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Lexibook - Linguistic Electronic System Société anonyme is showing 3 warning signs in our investment analysis , and 1 of those is concerning...

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. 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.
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