These 4 Measures Indicate That ADA Société Anonyme (EPA:ALADA) Is Using Debt Extensively

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that ADA Société Anonyme (EPA:ALADA) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for ADA Société Anonyme

How Much Debt Does ADA Société Anonyme Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 ADA Société Anonyme had €25.7m of debt, an increase on €22.7m, over one year. On the flip side, it has €3.81m in cash leading to net debt of about €21.9m.

How Strong Is ADA Société Anonyme's Balance Sheet?

According to the last reported balance sheet, ADA Société Anonyme had liabilities of €21.9m due within 12 months, and liabilities of €50.1m due beyond 12 months. Offsetting these obligations, it had cash of €3.81m as well as receivables valued at €73.5m due within 12 months. So it can boast €5.30m more liquid assets than total liabilities.

This excess liquidity suggests that ADA Société Anonyme is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders.

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).

With net debt to EBITDA of 4.5 ADA Société Anonyme has a fairly noticeable amount of debt. On the plus side, its EBIT was 8.8 times its interest expense, and its net debt to EBITDA, was quite high, at 4.5. Importantly, ADA Société Anonyme's EBIT fell a jaw-dropping 67% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 ADA Société Anonyme will need earnings to service that debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, ADA Société Anonyme saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Both ADA Société Anonyme's EBIT growth rate and its conversion of EBIT to free cash flow were discouraging. But its not so bad at covering its interest expense with its EBIT. Taking the abovementioned factors together we do think ADA Société Anonyme's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 5 warning signs for ADA Société Anonyme (of which 3 are significant!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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