Stock Analysis

Here's Why EuKedos (BIT:EUK) Is Weighed Down By Its Debt Load

BIT:EUK
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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that EuKedos S.p.A. (BIT:EUK) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for EuKedos

How Much Debt Does EuKedos Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 EuKedos had €16.3m of debt, an increase on €15.5m, over one year. However, it does have €2.64m in cash offsetting this, leading to net debt of about €13.6m.

debt-equity-history-analysis
BIT:EUK Debt to Equity History May 6th 2021

How Healthy Is EuKedos' Balance Sheet?

The latest balance sheet data shows that EuKedos had liabilities of €24.1m due within a year, and liabilities of €93.9m falling due after that. Offsetting these obligations, it had cash of €2.64m as well as receivables valued at €5.97m due within 12 months. So its liabilities total €109.4m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the €26.4m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, EuKedos would likely require a major re-capitalisation if it had to pay its creditors today.

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). 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).

While we wouldn't worry about EuKedos's net debt to EBITDA ratio of 4.5, we think its super-low interest cover of 0.45 times is a sign of high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Worse, EuKedos's EBIT was down 72% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since EuKedos 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, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, EuKedos generated free cash flow amounting to a very robust 93% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

On the face of it, EuKedos's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. We should also note that Healthcare industry companies like EuKedos commonly do use debt without problems. We're quite clear that we consider EuKedos to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with EuKedos .

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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