Is Develia (WSE:DVL) A Risky Investment?

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. Importantly, Develia S.A. (WSE:DVL) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

See our latest analysis for Develia

What Is Develia's Debt?

The chart below, which you can click on for greater detail, shows that Develia had zł779.1m in debt in March 2021; about the same as the year before. On the flip side, it has zł360.9m in cash leading to net debt of about zł418.2m.

How Healthy Is Develia's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Develia had liabilities of zł898.4m due within 12 months and liabilities of zł631.5m due beyond that. Offsetting this, it had zł360.9m in cash and zł39.0m in receivables that were due within 12 months. So its liabilities total zł1.13b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of zł1.56b, so it does suggest shareholders should keep an eye on Develia's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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

Develia has a debt to EBITDA ratio of 3.4, which signals significant debt, but is still pretty reasonable for most types of business. But its EBIT was about 1k times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. Importantly, Develia's EBIT fell a jaw-dropping 31% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Develia 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Develia's free cash flow amounted to 29% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Mulling over Develia's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Overall, we think it's fair to say that Develia has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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 Develia has 3 warning signs (and 1 which is a bit unpleasant) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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