These 4 Measures Indicate That Corticeira Amorim S.G.P.S (ELI:COR) Is Using Debt Reasonably Well

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Corticeira Amorim, S.G.P.S., S.A. (ELI:COR) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. 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.

View 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 €157.2m of debt in March 2021, down from €226.2m, one year before. However, it does have €88.3m in cash offsetting this, leading to net debt of about €68.9m.

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

We can see from the most recent balance sheet that Corticeira Amorim S.G.P.S had liabilities of €269.7m falling due within a year, and liabilities of €159.1m due beyond that. On the other hand, it had cash of €88.3m and €236.5m worth of receivables due within a year. So it has liabilities totalling €104.1m more than its cash and near-term receivables, combined.

Since publicly traded Corticeira Amorim S.G.P.S shares are worth a total of €1.45b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). 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 0.60. And its EBIT easily covers its interest expense, being 56.0 times the size. So we're pretty relaxed about its super-conservative use of debt. On the other hand, Corticeira Amorim S.G.P.S's EBIT dived 15%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Corticeira Amorim S.G.P.S's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Corticeira Amorim S.G.P.S's free cash flow amounted to 49% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

On our analysis Corticeira Amorim S.G.P.S's interest cover should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. To be specific, it seems about as good at (not) growing its EBIT as wet socks are at keeping your feet warm. Considering this range of data points, we think Corticeira Amorim S.G.P.S is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. Over time, share prices tend to follow earnings per share, so if you're interested in Corticeira Amorim S.G.P.S, you may well want to click here to check an interactive graph of its earnings per share history.

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.

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