Here's Why Alfen (AMS:ALFEN) Can Manage Its Debt Responsibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Alfen N.V. (AMS:ALFEN) does carry debt. But the more important question is: how much risk is that debt creating?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

Check out our latest analysis for Alfen

What Is Alfen's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Alfen had €6.86m of debt in June 2022, down from €7.43m, one year before. But it also has €35.4m in cash to offset that, meaning it has €28.5m net cash.

A Look At Alfen's Liabilities

The latest balance sheet data shows that Alfen had liabilities of €117.6m due within a year, and liabilities of €18.3m falling due after that. On the other hand, it had cash of €35.4m and €107.0m worth of receivables due within a year. So it can boast €6.46m more liquid assets than total liabilities.

This state of affairs indicates that Alfen's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the €2.14b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Alfen has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Alfen grew its EBIT by 99% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Alfen's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Alfen has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Alfen created free cash flow amounting to 11% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Alfen has net cash of €28.5m, as well as more liquid assets than liabilities. And we liked the look of last year's 99% year-on-year EBIT growth. So we don't think Alfen's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Alfen has 3 warning signs (and 1 which is a bit concerning) we think you should know about.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.