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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that CTT - Correios De Portugal, S.A. (ELI:CTT) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
What Is CTT - Correios De Portugal's Debt?
As you can see below, CTT - Correios De Portugal had €130.9m of debt at March 2021, down from €159.3m a year prior. But on the other hand it also has €643.9m in cash, leading to a €513.0m net cash position.
How Healthy Is CTT - Correios De Portugal's Balance Sheet?
According to the last reported balance sheet, CTT - Correios De Portugal had liabilities of €2.32b due within 12 months, and liabilities of €488.3m due beyond 12 months. Offsetting this, it had €643.9m in cash and €277.8m in receivables that were due within 12 months. So it has liabilities totalling €1.89b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the €712.5m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, CTT - Correios De Portugal would probably need a major re-capitalization if its creditors were to demand repayment. CTT - Correios De Portugal boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.
On the other hand, CTT - Correios De Portugal saw its EBIT drop by 4.3% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 CTT - Correios De Portugal can strengthen its balance sheet over time. 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. While CTT - Correios De Portugal has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, CTT - Correios De Portugal actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While CTT - Correios De Portugal does have more liabilities than liquid assets, it also has net cash of €513.0m. The cherry on top was that in converted 418% of that EBIT to free cash flow, bringing in €365m. So although we see some areas for improvement, we're not too worried about CTT - Correios De Portugal's 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. To that end, you should be aware of the 3 warning signs we've spotted with CTT - Correios De Portugal .
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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