We Think CTT - Correios De Portugal (ELI:CTT) Is Taking Some Risk With Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, CTT - Correios De Portugal, S.A. (ELI:CTT) does carry 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

View our latest analysis for CTT - Correios De Portugal

What Is CTT - Correios De Portugal's Debt?

The image below, which you can click on for greater detail, shows that CTT - Correios De Portugal had debt of €152.4m at the end of June 2020, a reduction from €161.8m over a year. But it also has €464.3m in cash to offset that, meaning it has €311.9m net cash.

How Strong Is CTT - Correios De Portugal's Balance Sheet?

According to the last reported balance sheet, CTT - Correios De Portugal had liabilities of €2.01b due within 12 months, and liabilities of €497.3m due beyond 12 months. On the other hand, it had cash of €464.3m and €258.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €1.79b.

The deficiency here weighs heavily on the €360.0m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, CTT - Correios De Portugal would probably need a major re-capitalization if its creditors were to demand repayment. Given that CTT - Correios De Portugal has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

The modesty of its debt load may become crucial for CTT - Correios De Portugal if management cannot prevent a repeat of the 32% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. Over the last three years, CTT - Correios De Portugal actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

Although CTT - Correios De Portugal's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €311.9m. And it impressed us with free cash flow of €222m, being 274% of its EBIT. Despite the cash, we do find CTT - Correios De Portugal's level of total liabilities concerning, so we're not particularly comfortable with the stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 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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