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. 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. As with many other companies Precia SA (EPA:PREC) makes use of debt. But the real question is whether this debt is making the company risky.
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Precia's Debt?
The image below, which you can click on for greater detail, shows that at June 2019 Precia had debt of €17.0m, up from €17.3 in one year. However, its balance sheet shows it holds €31.1m in cash, so it actually has €14.2m net cash.
A Look At Precia's Liabilities
The latest balance sheet data shows that Precia had liabilities of €49.2m due within a year, and liabilities of €18.6m falling due after that. On the other hand, it had cash of €31.1m and €36.0m worth of receivables due within a year. So these liquid assets roughly match the total liabilities.
This state of affairs indicates that Precia's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the €109.2m company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Precia boasts net cash, so it's fair to say it does not have a heavy debt load!
Fortunately, Precia grew its EBIT by 6.1% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is Precia's earnings that will influence how the balance sheet holds up in the future. 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 company can only pay off debt with cold hard cash, not accounting profits. Precia 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 most recent three years, Precia recorded free cash flow worth 61% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Precia has €14.2m in net cash. So we don't think Precia's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Precia, you may well want to click here to check an interactive graph of its earnings per share history.
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.
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.
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