Warren Buffett famously said, '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. Importantly, ADLPartner (EPA:ALP) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for ADLPartner
What Is ADLPartner's Debt?
As you can see below, ADLPartner had €7.17m of debt at June 2020, down from €7.58m a year prior. However, it does have €39.2m in cash offsetting this, leading to net cash of €32.1m.
How Healthy Is ADLPartner's Balance Sheet?
We can see from the most recent balance sheet that ADLPartner had liabilities of €66.5m falling due within a year, and liabilities of €20.3m due beyond that. On the other hand, it had cash of €39.2m and €34.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €13.5m.
ADLPartner has a market capitalization of €58.3m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, ADLPartner boasts net cash, so it's fair to say it does not have a heavy debt load!
On the other hand, ADLPartner saw its EBIT drop by 5.5% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is ADLPartner'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. ADLPartner 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, ADLPartner generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
Summing up
While ADLPartner does have more liabilities than liquid assets, it also has net cash of €32.1m. And it impressed us with free cash flow of €18m, being 86% of its EBIT. So we are not troubled with ADLPartner's debt use. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with ADLPartner , and understanding them should be part of your investment process.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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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About ENXTPA:DKUPL
Outstanding track record with excellent balance sheet and pays a dividend.
