These 4 Measures Indicate That Cavotec (STO:CCC) Is Using Debt Reasonably Well

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. We can see that Cavotec SA (STO:CCC) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Cavotec

What Is Cavotec's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Cavotec had €14.7m of debt in September 2020, down from €25.0m, one year before. However, it does have €16.0m in cash offsetting this, leading to net cash of €1.37m.

How Healthy Is Cavotec's Balance Sheet?

The latest balance sheet data shows that Cavotec had liabilities of €57.6m due within a year, and liabilities of €38.4m falling due after that. Offsetting this, it had €16.0m in cash and €43.4m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €36.6m.

Of course, Cavotec has a market capitalization of €209.1m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Cavotec also has more cash than debt, so we're pretty confident it can manage its debt safely.

One way Cavotec could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 14%, as it did over the last year. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Cavotec 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Cavotec may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Cavotec 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.

Summing up

Although Cavotec's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €1.37m. The cherry on top was that in converted 118% of that EBIT to free cash flow, bringing in €14m. So is Cavotec's debt a risk? It doesn't seem so to us. 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 Cavotec is showing 1 warning sign in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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