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. We can see that Solutions 30 S.E. (EPA:ALS30) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. 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. 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.
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How Much Debt Does Solutions 30 Carry?
The image below, which you can click on for greater detail, shows that at December 2018 Solutions 30 had debt of €82.3m, up from €49.2m in one year. On the flip side, it has €69.9m in cash leading to net debt of about €12.4m.
How Healthy Is Solutions 30's Balance Sheet?
According to the last reported balance sheet, Solutions 30 had liabilities of €355.2m due within 12 months, and liabilities of €82.9m due beyond 12 months. Offsetting these obligations, it had cash of €69.9m as well as receivables valued at €286.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €82.0m.
Since publicly traded Solutions 30 shares are worth a total of €1.04b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Carrying virtually no net debt, Solutions 30 has a very light debt load indeed.
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.