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. 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, Artefact SA (EPA:ALATF) does carry debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Artefact's Net Debt?
As you can see below, Artefact had €15.2m of debt at December 2018, down from €20.1m a year prior. However, its balance sheet shows it holds €16.5m in cash, so it actually has €1.27m net cash.
How Strong Is Artefact's Balance Sheet?
According to the last reported balance sheet, Artefact had liabilities of €69.8m due within 12 months, and liabilities of €15.9m due beyond 12 months. Offsetting this, it had €16.5m in cash and €56.8m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €12.3m.
Of course, Artefact has a market capitalization of €67.9m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Artefact boasts net cash, so it's fair to say it does not have a heavy debt load!
Importantly, Artefact's EBIT fell a jaw-dropping 77% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 Artefact'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. While Artefact 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, Artefact saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
Although Artefact's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €1.27m. Despite its cash we think that Artefact seems to struggle to grow its EBIT, so we are wary of the stock. Even though Artefact lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check outhow earnings have been trending over the last few years.
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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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.