Is Emova Group (EPA:ALEMV) Using Too Much Debt?

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.' 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 can see that Emova Group SA (EPA:ALEMV) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Emova Group

What Is Emova Group's Debt?

As you can see below, Emova Group had €11.7m of debt, at March 2021, which is about the same as the year before. You can click the chart for greater detail. However, it also had €1.16m in cash, and so its net debt is €10.5m.

How Healthy Is Emova Group's Balance Sheet?

According to the last reported balance sheet, Emova Group had liabilities of €26.6m due within 12 months, and liabilities of €18.5m due beyond 12 months. Offsetting this, it had €1.16m in cash and €18.6m in receivables that were due within 12 months. So it has liabilities totalling €25.3m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the €13.5m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Emova Group would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Emova Group has a rather high debt to EBITDA ratio of 10.5 which suggests a meaningful debt load. However, its interest coverage of 2.8 is reasonably strong, which is a good sign. Worse, Emova Group's EBIT was down 27% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But it is Emova Group'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, 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. During the last three years, Emova Group burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Emova Group's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And even its net debt to EBITDA fails to inspire much confidence. Considering everything we've mentioned above, it's fair to say that Emova Group is carrying heavy debt load. If you harvest honey without a bee suit, you risk getting stung, so we'd probably stay away from this particular stock. 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. Be aware that Emova Group is showing 3 warning signs in our investment analysis , and 1 of those is potentially serious...

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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