Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that Asseco South Eastern Europe S.A. (WSE:ASE) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
What Is Asseco South Eastern Europe's Debt?
You can click the graphic below for the historical numbers, but it shows that Asseco South Eastern Europe had zł68.8m of debt in September 2020, down from zł102.5m, one year before. However, it does have zł180.3m in cash offsetting this, leading to net cash of zł111.5m.
A Look At Asseco South Eastern Europe's Liabilities
According to the last reported balance sheet, Asseco South Eastern Europe had liabilities of zł254.5m due within 12 months, and liabilities of zł118.6m due beyond 12 months. Offsetting this, it had zł180.3m in cash and zł183.0m in receivables that were due within 12 months. So its liabilities total zł9.82m more than the combination of its cash and short-term receivables.
Having regard to Asseco South Eastern Europe's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the zł2.06b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Asseco South Eastern Europe also has more cash than debt, so we're pretty confident it can manage its debt safely.
In addition to that, we're happy to report that Asseco South Eastern Europe has boosted its EBIT by 37%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Asseco South Eastern Europe can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Asseco South Eastern Europe 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. Over the last three years, Asseco South Eastern Europe recorded free cash flow worth a fulsome 98% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Asseco South Eastern Europe has zł111.5m in net cash. The cherry on top was that in converted 98% of that EBIT to free cash flow, bringing in zł177m. So is Asseco South Eastern Europe's debt a risk? It doesn't seem so to us. 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. Be aware that Asseco South Eastern Europe is showing 1 warning sign in our investment analysis , you should know about...
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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