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.” So it can be obvious that you need to consider debt, when you think about how risky a given stock is because too much debt can sink a business. Above all, Raval ACS Ltd. (TLV: RVL) carries a debt. But the real question is whether this debt makes the business risky.
When is Debt a Problem?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. 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.
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How much debt does the Raval ACS carry?
The graph below, which you can click for more details, shows that Raval ACS had € 93.5m in debt in September 2021; about the same as the year before. However, he also had 45.0 million euros in cash, so his net debt is 48.4 million euros.
How strong is Raval ACS’s balance sheet?
According to the last published balance sheet, Raval ACS had liabilities of 105.2 million euros within 12 months and liabilities of 51.1 million euros due beyond 12 months. On the other hand, it had cash of € 45.0 million and € 48.9 million in receivables within one year. It therefore has total liabilities of € 62.4 million more than its combined cash and short-term receivables.
Raval ACS has a market cap of 159.7 million euros, so it could most likely raise cash to improve its balance sheet, should the need arise. But it is clear that it is absolutely necessary to take a close look at whether it can manage its debt without dilution.
We measure a company’s indebtedness relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating the ease with which its earnings before interest and taxes (EBIT ) covers its interests. costs (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).
Raval ACS’s net debt is only 1.1 times its EBITDA. And its EBIT easily covers its interest costs, being 84.6 times higher. So we’re pretty relaxed about its ultra-conservative use of debt. On top of that, we are happy to report that Raval ACS has increased its EBIT by 33%, reducing the specter of future debt repayments. The balance sheet is clearly the area to focus on when analyzing debt. But you can’t look at debt in isolation; since Raval ACS will need income to repay this debt. So, when considering debt, it is really worth looking at the profit trend. Click here for an interactive snapshot.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Raval ACS has recorded free cash flow corresponding to 63% of its EBIT, which is close to normal, given that free cash flow excludes interest and taxes. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
The good news is that Raval ACS’s demonstrated ability to cover interest costs with EBIT delights us like a fluffy puppy does a toddler. And the good news doesn’t end there, as its EBIT growth rate also supports this impression! When zoomed out, Raval ACS appears to be using the debt quite sensibly; and that gets the nod from us. After all, reasonable leverage can increase returns on equity. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we have identified 1 warning sign for Raval ACS that you need to be aware of.
At the end of the day, it’s often best to focus on businesses that don’t have 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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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.