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'. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Freelance.com SA (EPA:ALFRE) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Freelance.com's Net Debt?
The image below, which you can click on for greater detail, shows that Freelance.com had debt of €11.6m at the end of June 2019, a reduction from €16.6m over a year. However, it does have €21.5m in cash offsetting this, leading to net cash of €9.91m.
How Strong Is Freelance.com's Balance Sheet?
According to the last reported balance sheet, Freelance.com had liabilities of €64.5m due within 12 months, and liabilities of €12.5m due beyond 12 months. Offsetting these obligations, it had cash of €21.5m as well as receivables valued at €51.7m due within 12 months. So it has liabilities totalling €3.85m more than its cash and near-term receivables, combined.
Of course, Freelance.com has a market capitalization of €103.2m, 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, Freelance.com also has more cash than debt, so we're pretty confident it can manage its debt safely.
On top of that, Freelance.com grew its EBIT by 53% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Freelance.com's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Freelance.com 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. Over the last three years, Freelance.com reported free cash flow worth 17% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Freelance.com has €9.91m in net cash. And we liked the look of last year's 53% year-on-year EBIT growth. So we don't think Freelance.com's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Freelance.com is showing 1 warning sign in our investment analysis , you should know about...
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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