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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Eurofins Scientific SE (EPA:ERF) does use debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Eurofins Scientific's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Eurofins Scientific had €2.99b of debt, an increase on €2.20b, over one year. However, it also had €304.6m in cash, and so its net debt is €2.69b.
How Strong Is Eurofins Scientific's Balance Sheet?
We can see from the most recent balance sheet that Eurofins Scientific had liabilities of €2.01b falling due within a year, and liabilities of €2.94b due beyond that. On the other hand, it had cash of €304.6m and €1.00b worth of receivables due within a year. So it has liabilities totalling €3.64b more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Eurofins Scientific has a market capitalization of €7.79b, 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.
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).
Eurofins Scientific's debt is 3.6 times its EBITDA, and its EBIT cover its interest expense 4.9 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. One way Eurofins Scientific could vanquish its debt would be if it stops borrowing more but conitinues to grow EBIT at around 18%, as it did over the last year. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Eurofins Scientific's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Eurofins Scientific recorded free cash flow of 46% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
On our analysis Eurofins Scientific's EBIT growth rate should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For example, its net debt to EBITDA makes us a little nervous about its debt. Looking at all this data makes us feel a little cautious about Eurofins Scientific's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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 Eurofins Scientific's earnings per share history for free.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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