Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from risk.” It is only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. We can see that Almirall, SA (BME: ALM) uses debt in his business. But should shareholders be concerned about its use of debt?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. If things really go wrong, lenders can take over the business. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we think of a business’s use of debt, we first look at cash flow and debt together.
What is Almirall’s net debt?
The image below, which you can click for more details, shows that Almirall had a debt of 480.9 million euros at the end of December 2020, a reduction of 503.5 million euros over one year . On the other hand, it has 165.6 million euros in cash, leading to a net debt of approximately 315.3 million euros.
A look at Almirall’s responsibilities
According to the latest published balance sheet, Almirall had liabilities of 474.6 million euros within 12 months and liabilities of 513.6 million euros due beyond 12 months. In return, he had € 165.6 million in cash and € 183.9 million in receivables due within 12 months. Its liabilities thus exceed the sum of its cash and its receivables (short term) by € 638.6 million.
Almirall has a market cap of 2.21 billion euros, so it could most likely raise funds to improve its balance sheet, should the need arise. But we absolutely want to keep our eyes open for indications that its debt is too risky.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
With net debt of just 1.4 times EBITDA, Almirall is arguably fairly cautious. And it has 9.9 times interest coverage, which is more than enough. Modest indebtedness may become crucial for Almirall if management cannot prevent a repeat of the 32% reduction in EBIT over the past year. When it comes to paying down debt, lower income is no more helpful to your health than sugary sodas. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future profits, more than anything, that will determine Almirall’s ability to maintain a healthy balance sheet going forward. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, Almirall has experienced substantial total negative free cash flow. While this may be the result of spending on growth, it makes debt much riskier.
Our point of view
At first glance, Almirall’s conversion of EBIT to free cash flow left us hesitant about the stock, and its EBIT growth rate was no more attractive than the single empty restaurant on the most night. responsible for the year. But on the bright side, his interest coverage is a good sign and makes us more optimistic. Looking at the balance sheet and taking all of these factors into account, we think debt makes Almirall stock a bit risky. Some people like this kind of risk, but we are aware of the potential pitfalls, so we would probably prefer him to carry less debt. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we discovered 1 warning sign for Almirall which you should know before investing here.
At the end of the day, it’s often best to focus on businesses with no net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
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