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. Importantly, Applus Services, S.A. (BME:APPS) does carry debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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.
See our latest analysis for Applus Services
How Much Debt Does Applus Services Carry?
As you can see below, Applus Services had €602.5m of debt at June 2019, down from €637.4m a year prior. However, because it has a cash reserve of €133.2m, its net debt is less, at about €469.2m.
How Healthy Is Applus Services's Balance Sheet?
We can see from the most recent balance sheet that Applus Services had liabilities of €438.1m falling due within a year, and liabilities of €924.1m due beyond that. Offsetting these obligations, it had cash of €133.2m as well as receivables valued at €415.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €813.3m.
Applus Services has a market capitalization of €1.70b, 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.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).