We Think Alfen (AMS:ALFEN) Can Stay On Top Of Its Debt

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.' 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. We can see that Alfen N.V. (AMS:ALFEN) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Alfen

What Is Alfen's Net Debt?

As you can see below, Alfen had €5.96m of debt at December 2021, down from €6.95m a year prior. But it also has €47.3m in cash to offset that, meaning it has €41.3m net cash.

How Strong Is Alfen's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Alfen had liabilities of €79.9m due within 12 months and liabilities of €17.9m due beyond that. Offsetting these obligations, it had cash of €47.3m as well as receivables valued at €62.2m due within 12 months. So it can boast €11.6m 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 €1.92b 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 59% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Alfen can strengthen its balance sheet over time. 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. Alfen may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Alfen's free cash flow amounted to 30% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Alfen has net cash of €41.3m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 59% over the last year. So we don't think Alfen's use of debt is risky. 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. For example, we've discovered 2 warning signs for Alfen (1 is a bit concerning!) that you should be aware of before investing here.

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.