Here’s why Elgeka (ATH: ELGEK) is weighed down by her debt
David Iben put it well when he said, “Volatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. We notice that Elgeka SA (ATH: ELGEK) has a debt on its balance sheet. But the real question is whether this debt makes the business risky.
What risk does debt entail?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. 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 painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. Of course, many companies use debt to finance their growth without negative consequences. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
What is Elgeka’s net debt?
You can click on the graph below for historical figures, but it shows that as of December 2020 Elgeka had 71.6 million euros in debt, an increase from 65.9 million euros, on a year. However, it has 7.26 million euros in cash offsetting this, which leads to net debt of around 64.4 million euros.
Is Elgeka’s track record healthy?
Zooming in on the latest balance sheet data, we can see that Elgeka had a liability of 67.2 million euros due within 12 months and a liability of 83.5 million euros due beyond. In return, he had € 7.26 million in cash and € 39.6 million in receivables due within 12 months. It therefore has total liabilities of € 103.8 million more than its combined cash and short-term receivables.
This deficit casts a shadow over the € 8.57 million company, like a colossus dominating mere mortals. So we would be watching its record closely, without a doubt. After all, Elgeka would likely need a major recapitalization if she were to pay her creditors today.
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). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Elgeka shareholders face the double whammy of a high net debt / EBITDA ratio (7.2) and fairly low interest coverage, since EBIT is only 1.0 times expenses of interest. This means that we would consider him to be in heavy debt. The good news is that Elgeka has increased its EBIT by 39% over the past twelve months. Like the milk of human kindness, this type of growth increases resilience, making the business more capable of handling debt. When analyzing debt levels, the balance sheet is the obvious starting point. But you can’t look at debt in isolation; given that Elgeka will need income to repay this debt. So if you want to know more about his earnings, it might be worth checking out this graph of his long-term profit trend.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Elgeka has reported free cash flow of 11% of its EBIT, which is really pretty low. For us, the conversion to cash that elicits a bit of paranoia is the ability to extinguish debt.
Our point of view
At first glance, Elgeka’s interest coverage left us hesitant about the stock, and her total liability level was no more appealing than the only restaurant that was empty on the busiest night of the year. But on the positive side, its EBIT growth rate is a good sign and makes us more optimistic. Overall, it seems to us that Elgeka’s balance sheet is really very risky for the company. For this reason, we are quite cautious on the stock, and we believe that shareholders should closely monitor its liquidity. 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. To do this, you need to know the 1 warning sign we spotted with Elgeka .
If, after all of this, you’re more interested in a fast-growing company with a rock-solid balance sheet, then check out our list of cash net growth stocks without delay.
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