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 Origin Enterprises plc (ISE:OIZ) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, 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 Origin Enterprises's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of January 2019 Origin Enterprises had €323.0m of debt, an increase on €257.2m, over one year. However, because it has a cash reserve of €84.9m, its net debt is less, at about €238.2m.
How Strong Is Origin Enterprises's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Origin Enterprises had liabilities of €450.9m due within 12 months and liabilities of €346.8m due beyond that. Offsetting this, it had €84.9m in cash and €301.3m in receivables that were due within 12 months. So it has liabilities totalling €411.5m more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of €599.0m. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
With net debt to EBITDA of 2.8 Origin Enterprises has a fairly noticeable amount of debt. But the high interest coverage of 7.2 suggests it can easily service that debt. We saw Origin Enterprises grow its EBIT by 9.1% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. 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 Origin Enterprises can strengthen its balance sheet over time. 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Origin Enterprises's free cash flow amounted to 43% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Even if we have reservations about how easily Origin Enterprises is capable of staying on top of its total liabilities, its interest cover and EBIT growth rate make us think feel relatively unconcerned. We think that Origin Enterprises's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Origin Enterprises's dividend history, without delay!
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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