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. We note that Atari SA (EPA:ATA) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.
How Much Debt Does Atari Carry?
As you can see below, at the end of March 2020, Atari had €1.40m of debt, up from €700.0k a year ago. Click the image for more detail. However, it does have €1.80m in cash offsetting this, leading to net cash of €400.0k.
How Healthy Is Atari's Balance Sheet?
We can see from the most recent balance sheet that Atari had liabilities of €11.9m falling due within a year, and liabilities of €3.80m due beyond that. Offsetting this, it had €1.80m in cash and €2.80m in receivables that were due within 12 months. So it has liabilities totalling €11.1m more than its cash and near-term receivables, combined.
Of course, Atari has a market capitalization of €80.5m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Atari boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, Atari grew its EBIT by 65% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Atari can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Atari 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. During the last three years, Atari burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Although Atari's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €400.0k. And we liked the look of last year's 65% year-on-year EBIT growth. So we are not troubled with Atari'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. Case in point: We've spotted 3 warning signs for Atari you should be aware of, and 1 of them is a bit concerning.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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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