We Think Ekter (ATH:EKTER) Is Taking Some Risk With Its Debt

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 Ekter SA (ATH:EKTER) 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 is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Ekter

How Much Debt Does Ekter Carry?

As you can see below, at the end of December 2020, Ekter had €3.17m of debt, up from €2.50m a year ago. Click the image for more detail. However, it also had €1.74m in cash, and so its net debt is €1.44m.

How Strong Is Ekter's Balance Sheet?

We can see from the most recent balance sheet that Ekter had liabilities of €3.72m falling due within a year, and liabilities of €3.46m due beyond that. On the other hand, it had cash of €1.74m and €6.22m worth of receivables due within a year. So it actually has €777.2k more liquid assets than total liabilities.

This short term liquidity is a sign that Ekter could probably pay off its debt with ease, as its balance sheet is far from stretched.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Ekter's debt to EBITDA ratio (4.1) suggests that it uses some debt, its interest cover is very weak, at 0.64, suggesting high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. One redeeming factor for Ekter is that it turned last year's EBIT loss into a gain of €303k, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Ekter's earnings that will influence how the balance sheet holds up in the future. 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, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Ekter burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Both Ekter's conversion of EBIT to free cash flow and its interest cover were discouraging. But its not so bad at staying on top of its total liabilities. Taking the abovementioned factors together we do think Ekter's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. Be aware that Ekter is showing 3 warning signs in our investment analysis , and 1 of those is concerning...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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