Alten (EPA:ATE) Has A Rock Solid Balance Sheet

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. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Alten SA (EPA:ATE) does use debt in its business. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Alten

How Much Debt Does Alten Carry?

The chart below, which you can click on for greater detail, shows that Alten had €137.0m in debt in June 2019; about the same as the year before. On the flip side, it has €119.3m in cash leading to net debt of about €17.7m.

A Look At Alten's Liabilities

We can see from the most recent balance sheet that Alten had liabilities of €753.3m falling due within a year, and liabilities of €161.7m due beyond that. On the other hand, it had cash of €119.3m and €975.1m worth of receivables due within a year. So it can boast €179.3m more liquid assets than total liabilities.

This short term liquidity is a sign that Alten could probably pay off its debt with ease, as its balance sheet is far from stretched. Carrying virtually no net debt, Alten has a very light debt load indeed.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Alten has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.073 and EBIT of 114 times the interest expense. So relative to past earnings, the debt load seems trivial. Also good is that Alten grew its EBIT at 14% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Alten's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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 most recent three years, Alten recorded free cash flow worth 56% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, Alten's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its net debt to EBITDA also supports that impression! Zooming out, Alten seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. Over time, share prices tend to follow earnings per share, so if you're interested in Alten, you may well want to click here to check an interactive graph of its earnings per share history.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.