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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.’ So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Perseus SA (ATH:PERS) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.
What Is Perseus’s Net Debt?
The image below, which you can click on for greater detail, shows that Perseus had debt of €20.3m at the end of December 2018, a reduction from €22.7m over a year. However, it does have €9.27m in cash offsetting this, leading to net debt of about €11.0m.
How Strong Is Perseus’s Balance Sheet?
The latest balance sheet data shows that Perseus had liabilities of €23.2m due within a year, and liabilities of €19.7m falling due after that. Offsetting these obligations, it had cash of €9.27m as well as receivables valued at €40.7m due within 12 months. So it can boast €6.95m more liquid assets than total liabilities.
This luscious liquidity implies that Perseus’s balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Because it carries more debt than cash, we think it’s worth watching Perseus’s balance sheet over time.
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.
Perseus’s net debt of 1.98 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 9.93 times interest expense) certainly does not do anything to dispel this impression. If Perseus can keep growing EBIT at last year’s rate of 20% over the last year, then it will find its debt load easier to manage. There’s no doubt that we learn most about debt from the balance sheet. But it is Perseus’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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Perseus actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us excited like the crowd when the beat drops at a Daft Punk concert.
Happily, Perseus’s impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And the good news does not stop there, as its interest cover also supports that impression! It looks Perseus has no trouble standing on its own two feet, and it has no reason to fear its lenders. For investing nerds like us its balance sheet is almost charming. Over time, share prices tend to follow earnings per share, so if you’re interested in Perseus, you may well want to click here to check an interactive graph of its earnings per share history.
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.