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 can see that Apator S.A. (WSE:APT) does use debt in its business. But should shareholders be worried about its use of debt?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Apator's Net Debt?
The chart below, which you can click on for greater detail, shows that Apator had zł140.1m in debt in March 2021; about the same as the year before. However, because it has a cash reserve of zł40.9m, its net debt is less, at about zł99.2m.
How Healthy Is Apator's Balance Sheet?
The latest balance sheet data shows that Apator had liabilities of zł342.1m due within a year, and liabilities of zł49.0m falling due after that. On the other hand, it had cash of zł40.9m and zł221.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by zł128.7m.
Since publicly traded Apator shares are worth a total of zł703.9m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Apator's net debt is only 0.90 times its EBITDA. And its EBIT easily covers its interest expense, being 39.2 times the size. So we're pretty relaxed about its super-conservative use of debt. The good news is that Apator has increased its EBIT by 5.9% over twelve months, which should ease any concerns about debt repayment. 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 Apator 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Apator produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Apator's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its net debt to EBITDA is also very heartening. Looking at all the aforementioned factors together, it strikes us that Apator can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Apator is showing 3 warning signs in our investment analysis , and 1 of those can't be ignored...
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
If you decide to trade Apator, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.