Is Claranova (EPA:CLA) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Claranova SE (EPA:CLA) does carry debt. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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, 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.

View our latest analysis for Claranova

What Is Claranova's Net Debt?

As you can see below, at the end of June 2020, Claranova had €68.9m of debt, up from €51.8m a year ago. Click the image for more detail. But on the other hand it also has €82.8m in cash, leading to a €13.9m net cash position.

How Healthy Is Claranova's Balance Sheet?

We can see from the most recent balance sheet that Claranova had liabilities of €74.6m falling due within a year, and liabilities of €73.1m due beyond that. Offsetting these obligations, it had cash of €82.8m as well as receivables valued at €14.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €50.6m.

While this might seem like a lot, it is not so bad since Claranova has a market capitalization of €240.7m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Claranova boasts net cash, so it's fair to say it does not have a heavy debt load!

Unfortunately, Claranova saw its EBIT slide 5.6% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. 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 Claranova 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Claranova 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. Happily for any shareholders, Claranova actually produced more free cash flow than EBIT over the last two years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

Although Claranova's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €13.9m. The cherry on top was that in converted 149% of that EBIT to free cash flow, bringing in €28m. So we are not troubled with Claranova's debt use. When analysing debt levels, the balance sheet is the obvious place to start. 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 2 warning signs with Claranova (at least 1 which is significant) , and understanding them should be part of your investment process.

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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