These 4 Measures Indicate That Excellence (WSE:EXC) Is Using Debt Reasonably Well

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Excellence S.A. (WSE:EXC) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Excellence

What Is Excellence's Net Debt?

As you can see below, at the end of June 2021, Excellence had zł9.18m of debt, up from zł824.8k a year ago. Click the image for more detail. However, it also had zł465.6k in cash, and so its net debt is zł8.71m.

A Look At Excellence's Liabilities

The latest balance sheet data shows that Excellence had liabilities of zł16.2m due within a year, and liabilities of zł2.72m falling due after that. On the other hand, it had cash of zł465.6k and zł10.00m worth of receivables due within a year. So its liabilities total zł8.42m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Excellence is worth zł40.1m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

We'd say that Excellence's moderate net debt to EBITDA ratio ( being 2.2), indicates prudence when it comes to debt. And its strong interest cover of 138 times, makes us even more comfortable. We also note that Excellence improved its EBIT from a last year's loss to a positive zł2.4m. 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 Excellence 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Excellence reported free cash flow worth 17% 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

On our analysis Excellence's interest cover should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to convert EBIT to free cash flow. When we consider all the factors mentioned above, we do feel a bit cautious about Excellence's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. For example, we've discovered 3 warning signs for Excellence (1 is a bit unpleasant!) that you should be aware of before investing here.

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.

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.

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