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. 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. Importantly, Centrale d'Achat Française pour l'Outre-Mer Société Anonyme (EPA:CAFO) does carry debt. 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. 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. 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 Centrale d'Achat Française pour l'Outre-Mer Société Anonyme Carry?
As you can see below, Centrale d'Achat Française pour l'Outre-Mer Société Anonyme had €62.9m of debt, at March 2019, which is about the same the year before. You can click the chart for greater detail. However, it also had €19.1m in cash, and so its net debt is €43.8m.
How Strong Is Centrale d'Achat Française pour l'Outre-Mer Société Anonyme's Balance Sheet?
We can see from the most recent balance sheet that Centrale d'Achat Française pour l'Outre-Mer Société Anonyme had liabilities of €166.6m falling due within a year, and liabilities of €64.7m due beyond that. Offsetting this, it had €19.1m in cash and €58.2m in receivables that were due within 12 months. So its liabilities total €154.0m more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the €50.6m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt After all, Centrale d'Achat Française pour l'Outre-Mer Société Anonyme would likely require a major re-capitalisation if it had to pay its creditors today.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Centrale d'Achat Française pour l'Outre-Mer Société Anonyme's debt is 3.1 times its EBITDA, and its EBIT cover its interest expense 2.5 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Worse, Centrale d'Achat Française pour l'Outre-Mer Société Anonyme's EBIT was down 58% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Centrale d'Achat Française pour l'Outre-Mer Société Anonyme will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Centrale d'Achat Française pour l'Outre-Mer Société Anonyme 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.
On the face of it, Centrale d'Achat Française pour l'Outre-Mer Société Anonyme's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And even its interest cover fails to inspire much confidence. We think the chances that Centrale d'Achat Française pour l'Outre-Mer Société Anonyme has too much debt a very significant. To our minds, that means the stock is rather high risk, and probably one to avoid; but to each their own (investing) style. Even though Centrale d'Achat Française pour l'Outre-Mer Société Anonyme 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.
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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If you spot an error that warrants correction, please contact the editor at email@example.com. 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.