Corticeira Amorim S.G.P.S (ELI:COR) Seems To Use Debt Quite Sensibly

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 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. We can see that Corticeira Amorim, S.G.P.S., S.A. (ELI:COR) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Corticeira Amorim S.G.P.S

How Much Debt Does Corticeira Amorim S.G.P.S Carry?

You can click the graphic below for the historical numbers, but it shows that Corticeira Amorim S.G.P.S had €155.3m of debt in September 2020, down from €188.5m, one year before. However, it also had €43.6m in cash, and so its net debt is €111.7m.

How Healthy Is Corticeira Amorim S.G.P.S's Balance Sheet?

The latest balance sheet data shows that Corticeira Amorim S.G.P.S had liabilities of €338.5m due within a year, and liabilities of €129.1m falling due after that. Offsetting this, it had €43.6m in cash and €214.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €209.4m.

Since publicly traded Corticeira Amorim S.G.P.S shares are worth a total of €1.36b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

Corticeira Amorim S.G.P.S has a low net debt to EBITDA ratio of only 0.93. And its EBIT covers its interest expense a whopping 64.2 times over. So we're pretty relaxed about its super-conservative use of debt. On the other hand, Corticeira Amorim S.G.P.S saw its EBIT drop by 2.5% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. 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 Corticeira Amorim S.G.P.S 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Corticeira Amorim S.G.P.S recorded free cash flow of 45% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

When it comes to the balance sheet, the standout positive for Corticeira Amorim S.G.P.S was the fact that it seems able to cover its interest expense with its EBIT confidently. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to grow its EBIT. When we consider all the elements mentioned above, it seems to us that Corticeira Amorim S.G.P.S is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Corticeira Amorim S.G.P.S you should be aware of.

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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