Quest Holdings (ATH:QUEST) Seems To Use Debt Quite Sensibly

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Quest Holdings S.A. (ATH:QUEST) does carry debt. But is this debt a concern to shareholders?

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. 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.

View our latest analysis for Quest Holdings

What Is Quest Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Quest Holdings had €88.2m of debt, an increase on €70.9m, over one year. However, it does have €78.5m in cash offsetting this, leading to net debt of about €9.67m.

How Healthy Is Quest Holdings's Balance Sheet?

The latest balance sheet data shows that Quest Holdings had liabilities of €182.9m due within a year, and liabilities of €117.6m falling due after that. On the other hand, it had cash of €78.5m and €158.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €63.9m.

Since publicly traded Quest Holdings shares are worth a total of €366.1m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Quest Holdings has net debt of just 0.25 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 9.0 times, which is more than adequate. In addition to that, we're happy to report that Quest Holdings has boosted its EBIT by 59%, thus reducing the spectre of future debt repayments. 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 Quest Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. In the last three years, Quest Holdings's free cash flow amounted to 38% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

The good news is that Quest Holdings's demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. Taking all this data into account, it seems to us that Quest Holdings 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. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - Quest Holdings has 1 warning sign we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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