The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 should shareholders be worried about its use of debt?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for ADLPartner
What Is ADLPartner's Net Debt?
As you can see below, at the end of December 2020, ADLPartner had €13.3m of debt, up from €6.85m a year ago. Click the image for more detail. However, its balance sheet shows it holds €42.5m in cash, so it actually has €29.2m net cash.
How Healthy Is ADLPartner's Balance Sheet?
The latest balance sheet data shows that ADLPartner had liabilities of €76.6m due within a year, and liabilities of €25.7m falling due after that. Offsetting this, it had €42.5m in cash and €42.8m in receivables that were due within 12 months. So its liabilities total €17.0m more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since ADLPartner has a market capitalization of €67.7m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, ADLPartner also has more cash than debt, so we're pretty confident it can manage its debt safely.
But the bad news is that ADLPartner has seen its EBIT plunge 10% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But it is ADLPartner's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While ADLPartner 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, ADLPartner recorded free cash flow worth a fulsome 88% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
Summing up
Although ADLPartner's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €29.2m. And it impressed us with free cash flow of €18m, being 88% of its EBIT. So we don't have any problem with ADLPartner's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for ADLPartner that you should be aware of before investing here.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.
