David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Técnicas Reunidas, S.A. (BME:TRE) 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Técnicas Reunidas Carry?
The image below, which you can click on for greater detail, shows that at March 2019 Técnicas Reunidas had debt of €529.0m, up from €478.6m in one year. But on the other hand it also has €748.2m in cash, leading to a €219.2m net cash position.
How Strong Is Técnicas Reunidas's Balance Sheet?
According to the last reported balance sheet, Técnicas Reunidas had liabilities of €3.04b due within 12 months, and liabilities of €508.9m due beyond 12 months. On the other hand, it had cash of €748.2m and €2.53b worth of receivables due within a year. So its liabilities total €262.3m more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Técnicas Reunidas has a market capitalization of €1.13b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Técnicas Reunidas boasts net cash, so it's fair to say it does not have a heavy debt load!
The good news is that Técnicas Reunidas has increased its EBIT by 4.3% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Técnicas Reunidas'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Técnicas Reunidas 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. Considering the last three years, Técnicas Reunidas actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
Although Técnicas Reunidas's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €219m. And it also grew its EBIT by 4.3% over the last year. So we are not troubled with Técnicas Reunidas's debt use. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Técnicas Reunidas's earnings per share history for free.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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