These 4 Measures Indicate That Allegro.eu (WSE:ALE) Is Using Debt Safely

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, Allegro.eu S.A. (WSE:ALE) does carry debt. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Allegro.eu

How Much Debt Does Allegro.eu Carry?

As you can see below, Allegro.eu had zł6.08b of debt at September 2024, down from zł6.45b a year prior. However, because it has a cash reserve of zł3.84b, its net debt is less, at about zł2.24b.

A Look At Allegro.eu's Liabilities

We can see from the most recent balance sheet that Allegro.eu had liabilities of zł2.27b falling due within a year, and liabilities of zł7.12b due beyond that. On the other hand, it had cash of zł3.84b and zł726.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by zł4.83b.

Given Allegro.eu has a market capitalization of zł30.4b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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 Allegro.eu's low debt to EBITDA ratio of 0.98 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 6.4 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. On top of that, Allegro.eu grew its EBIT by 32% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Allegro.eu's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Allegro.eu actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

The good news is that Allegro.eu's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Zooming out, Allegro.eu seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. We've identified 1 warning sign with Allegro.eu , and understanding them should be part of your investment process.

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.

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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.