Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. As with many other companies Peugeot S.A. (EPA:UG) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 Peugeot's Net Debt?
As you can see below, at the end of June 2019, Peugeot had €8.69b of debt, up from €7.61b a year ago. Click the image for more detail. However, it does have €17.2b in cash offsetting this, leading to net cash of €8.49b.
How Healthy Is Peugeot's Balance Sheet?
The latest balance sheet data shows that Peugeot had liabilities of €31.4b due within a year, and liabilities of €16.5b falling due after that. Offsetting this, it had €17.2b in cash and €5.93b in receivables that were due within 12 months. So its liabilities total €24.8b more than the combination of its cash and short-term receivables.
When you consider that this deficiency exceeds the company's huge €20.3b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. Given that Peugeot 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.
Another good sign is that Peugeot has been able to increase its EBIT by 21% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Peugeot 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. Peugeot may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Peugeot produced sturdy free cash flow equating to 56% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While Peugeot does have more liabilities than liquid assets, it also has net cash of €8.49b. And we liked the look of last year's 21% year-on-year EBIT growth. So we are not troubled with Peugeot's debt use. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Peugeot's dividend history, without delay!
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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