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 CompuGroup Medical Societas Europaea (ETR:COP) does have debt on its balance sheet. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is CompuGroup Medical Societas Europaea's Net Debt?
As you can see below, CompuGroup Medical Societas Europaea had €337.8m of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. On the flip side, it has €43.5m in cash leading to net debt of about €294.3m.
How Healthy Is CompuGroup Medical Societas Europaea's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that CompuGroup Medical Societas Europaea had liabilities of €241.0m due within 12 months and liabilities of €455.2m due beyond that. Offsetting this, it had €43.5m in cash and €124.7m in receivables that were due within 12 months. So it has liabilities totalling €528.1m more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since CompuGroup Medical Societas Europaea has a market capitalization of €2.50b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
CompuGroup Medical Societas Europaea's net debt to EBITDA ratio of about 1.9 suggests only moderate use of debt. And its commanding EBIT of 21.3 times its interest expense, implies the debt load is as light as a peacock feather. Sadly, CompuGroup Medical Societas Europaea's EBIT actually dropped 3.6% in the last year. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if CompuGroup Medical Societas Europaea can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, CompuGroup Medical Societas Europaea produced sturdy free cash flow equating to 71% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
CompuGroup Medical Societas Europaea's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its EBIT growth rate does undermine this impression a bit. We would also note that Healthcare Services industry companies like CompuGroup Medical Societas Europaea commonly do use debt without problems. Taking all this data into account, it seems to us that CompuGroup Medical Societas Europaea takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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 CompuGroup Medical Societas Europaea's earnings per share history for free.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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.
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. Thank you for reading.