Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about. 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 Unieuro S.p.A. (BIT:UNIR) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Unieuro's Net Debt?
The image below, which you can click on for greater detail, shows that at November 2019 Unieuro had debt of €52.1m, up from €65.3 in one year. However, its balance sheet shows it holds €104.8m in cash, so it actually has €52.8m net cash.
A Look At Unieuro's Liabilities
Zooming in on the latest balance sheet data, we can see that Unieuro had liabilities of €973.9m due within 12 months and liabilities of €472.0m due beyond that. On the other hand, it had cash of €104.8m and €81.9m worth of receivables due within a year. So its liabilities total €1.26b more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the €259.2m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Unieuro would likely require a major re-capitalisation if it had to pay its creditors today. Given that Unieuro has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.
Also relevant is that Unieuro has grown its EBIT by a very respectable 25% in the last year, thus enhancing its ability to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Unieuro'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Unieuro has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Unieuro actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Although Unieuro's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €52.8m. The cherry on top was that in converted 169% of that EBIT to free cash flow, bringing in €102m. So we don't have any problem with Unieuro's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Unieuro you should be aware of.
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.
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.