Does Eurocell (LON:ECEL) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 note that Eurocell plc (LON:ECEL) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Eurocell

How Much Debt Does Eurocell Carry?

As you can see below, Eurocell had UK£6.60m of debt at June 2021, down from UK£26.4m a year prior. However, its balance sheet shows it holds UK£7.90m in cash, so it actually has UK£1.30m net cash.

How Strong Is Eurocell's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Eurocell had liabilities of UK£65.2m due within 12 months and liabilities of UK£56.8m due beyond that. Offsetting these obligations, it had cash of UK£7.90m as well as receivables valued at UK£48.0m due within 12 months. So its liabilities total UK£66.1m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Eurocell is worth UK£314.1m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Eurocell also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Eurocell grew its EBIT by 147% over twelve months. That boost will make it even easier to pay down debt going forward. 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 Eurocell'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Eurocell has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Eurocell generated free cash flow amounting to a very robust 91% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While Eurocell does have more liabilities than liquid assets, it also has net cash of UK£1.30m. The cherry on top was that in converted 91% of that EBIT to free cash flow, bringing in UK£36m. So is Eurocell's debt a risk? It doesn't seem so to us. 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. We've identified 2 warning signs with Eurocell , and understanding them should be part of your investment process.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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