These 4 Measures Indicate That Elvalhalcor Hellenic Copper and Aluminium Industry (ATH:ELHA) Is Using Debt In A Risky Way

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. As with many other companies Elvalhalcor Hellenic Copper and Aluminium Industry S.A. (ATH:ELHA) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Elvalhalcor Hellenic Copper and Aluminium Industry

How Much Debt Does Elvalhalcor Hellenic Copper and Aluminium Industry Carry?

As you can see below, at the end of September 2020, Elvalhalcor Hellenic Copper and Aluminium Industry had €692.2m of debt, up from €621.1m a year ago. Click the image for more detail. However, it also had €39.5m in cash, and so its net debt is €652.7m.

A Look At Elvalhalcor Hellenic Copper and Aluminium Industry's Liabilities

Zooming in on the latest balance sheet data, we can see that Elvalhalcor Hellenic Copper and Aluminium Industry had liabilities of €490.7m due within 12 months and liabilities of €588.0m due beyond that. Offsetting these obligations, it had cash of €39.5m as well as receivables valued at €276.7m due within 12 months. So it has liabilities totalling €762.5m more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's €637.9m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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).

Weak interest cover of 2.2 times and a disturbingly high net debt to EBITDA ratio of 6.0 hit our confidence in Elvalhalcor Hellenic Copper and Aluminium Industry like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, Elvalhalcor Hellenic Copper and Aluminium Industry saw its EBIT tank 53% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Elvalhalcor Hellenic Copper and Aluminium Industry 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.

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. Over the last three years, Elvalhalcor Hellenic Copper and Aluminium Industry reported free cash flow worth 9.3% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

To be frank both Elvalhalcor Hellenic Copper and Aluminium Industry's net debt to EBITDA and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. And even its level of total liabilities fails to inspire much confidence. After considering the datapoints discussed, we think Elvalhalcor Hellenic Copper and Aluminium Industry has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. To that end, you should learn about the 2 warning signs we've spotted with Elvalhalcor Hellenic Copper and Aluminium Industry (including 1 which is a bit unpleasant) .

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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