Is Paragon ID (EPA:PID) Using Debt In A Risky Way?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Paragon ID SA (EPA:PID) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Paragon ID

How Much Debt Does Paragon ID Carry?

As you can see below, Paragon ID had €51.0m of debt at December 2020, down from €54.1m a year prior. However, it also had €12.6m in cash, and so its net debt is €38.4m.

How Strong Is Paragon ID's Balance Sheet?

According to the last reported balance sheet, Paragon ID had liabilities of €48.9m due within 12 months, and liabilities of €47.9m due beyond 12 months. Offsetting these obligations, it had cash of €12.6m as well as receivables valued at €11.5m due within 12 months. So it has liabilities totalling €72.7m more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's €53.0m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Paragon ID will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Paragon ID made a loss at the EBIT level, and saw its revenue drop to €92m, which is a fall of 19%. We would much prefer see growth.

Caveat Emptor

Not only did Paragon ID's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost €2.4m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. It's fair to say the loss of €7.8m didn't encourage us either; we'd like to see a profit. In the meantime, we consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Paragon ID (of which 1 doesn't sit too well with us!) you should know about.

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.

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