The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that A.S. Création Tapeten AG (ETR:ACWN) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is A.S. Création Tapeten's Debt?
You can click the graphic below for the historical numbers, but it shows that A.S. Création Tapeten had €16.1m of debt in June 2019, down from €18.1m, one year before. However, it does have €22.6m in cash offsetting this, leading to net cash of €6.57m.
How Strong Is A.S. Création Tapeten's Balance Sheet?
We can see from the most recent balance sheet that A.S. Création Tapeten had liabilities of €38.1m falling due within a year, and liabilities of €28.1m due beyond that. Offsetting these obligations, it had cash of €22.6m as well as receivables valued at €30.6m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €13.0m.
This deficit isn't so bad because A.S. Création Tapeten is worth €38.3m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, A.S. Création Tapeten boasts net cash, so it's fair to say it does not have a heavy debt load!
It was also good to see that despite losing money on the EBIT line last year, A.S. Création Tapeten turned things around in the last 12 months, delivering and EBIT of €1.4m. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if A.S. Création Tapeten 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While A.S. Création Tapeten 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. Happily for any shareholders, A.S. Création Tapeten actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
While A.S. Création Tapeten does have more liabilities than liquid assets, it also has net cash of €6.57m. And it impressed us with free cash flow of €2.2m, being 158% of its EBIT. So we are not troubled with A.S. Création Tapeten's debt use. Even though A.S. Création Tapeten 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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