Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 CTT - Correios De Portugal, S.A. (ELI:CTT) 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 is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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 CTT - Correios De Portugal's Debt?
The image below, which you can click on for greater detail, shows that at June 2019 CTT - Correios De Portugal had debt of €161.8m, up from €2.54m in one year. But on the other hand it also has €395.5m in cash, leading to a €233.7m net cash position.
A Look At CTT - Correios De Portugal's Liabilities
The latest balance sheet data shows that CTT - Correios De Portugal had liabilities of €1.67b due within a year, and liabilities of €488.9m falling due after that. Offsetting these obligations, it had cash of €395.5m as well as receivables valued at €249.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €1.52b.
This deficit casts a shadow over the €298.8m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, CTT - Correios De Portugal would probably need a major re-capitalization if its creditors were to demand repayment. CTT - Correios De Portugal boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.
Better yet, CTT - Correios De Portugal grew its EBIT by 116% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if CTT - Correios De Portugal 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. CTT - Correios De Portugal 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, CTT - Correios De Portugal actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Although CTT - Correios De Portugal's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €234m. The cherry on top was that in converted 317% of that EBIT to free cash flow, bringing in -€23.7m. So we don't have any problem with CTT - Correios De Portugal's use of debt. Given CTT - Correios De Portugal has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
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 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.