Stock Analysis

Is Elton International Trading (ATH:ELTON) A Risky Investment?

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ATSE:ELTON
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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.' 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 Elton International Trading Company S.A. (ATH:ELTON) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Elton International Trading

What Is Elton International Trading's Debt?

You can click the graphic below for the historical numbers, but it shows that Elton International Trading had €20.3m of debt in December 2020, down from €23.2m, one year before. However, it does have €6.79m in cash offsetting this, leading to net debt of about €13.5m.

debt-equity-history-analysis
ATSE:ELTON Debt to Equity History May 21st 2021

How Healthy Is Elton International Trading's Balance Sheet?

We can see from the most recent balance sheet that Elton International Trading had liabilities of €24.6m falling due within a year, and liabilities of €14.9m due beyond that. Offsetting this, it had €6.79m in cash and €43.6m in receivables that were due within 12 months. So it actually has €11.0m more liquid assets than total liabilities.

It's good to see that Elton International Trading has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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 a debt to EBITDA ratio of 1.8, Elton International Trading uses debt artfully but responsibly. And the alluring interest cover (EBIT of 7.8 times interest expense) certainly does not do anything to dispel this impression. Notably Elton International Trading's EBIT was pretty flat over the last year. Ideally it can diminish its debt load by kick-starting earnings growth. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Elton International Trading 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Elton International Trading produced sturdy free cash flow equating to 56% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, Elton International Trading's impressive level of total liabilities implies it has the upper hand on its debt. And its interest cover is good too. Taking all this data into account, it seems to us that Elton International Trading takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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. Be aware that Elton International Trading is showing 2 warning signs in our investment analysis , 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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