Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Euromoney Institutional Investor PLC (LON:ERM) does use debt in its business. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Euromoney Institutional Investor's Debt?
The image below, which you can click on for greater detail, shows that at March 2020 Euromoney Institutional Investor had debt of UK£68.6m, up from none in one year. But on the other hand it also has UK£76.7m in cash, leading to a UK£8.08m net cash position.
How Strong Is Euromoney Institutional Investor's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Euromoney Institutional Investor had liabilities of UK£232.5m due within 12 months and liabilities of UK£175.4m due beyond that. Offsetting these obligations, it had cash of UK£76.7m as well as receivables valued at UK£90.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£241.0m.
Euromoney Institutional Investor has a market capitalization of UK£869.7m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Euromoney Institutional Investor also has more cash than debt, so we're pretty confident it can manage its debt safely.
It is just as well that Euromoney Institutional Investor's load is not too heavy, because its EBIT was down 66% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Euromoney Institutional Investor's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Euromoney Institutional Investor 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. During the last three years, Euromoney Institutional Investor produced sturdy free cash flow equating to 73% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Although Euromoney Institutional Investor's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of UK£8.08m. The cherry on top was that in converted 73% of that EBIT to free cash flow, bringing in UK£33m. So we are not troubled with Euromoney Institutional Investor's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Euromoney Institutional Investor that you should be aware of before investing here.
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.
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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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