Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We can see that Limited EML payments (ASX:EML) uses debt in his business. But should shareholders worry about its use of debt?
What risk does debt carry?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. If things go really bad, lenders can take over the business. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
How much debt do EML payments carry?
You can click on the chart below for historical figures, but it shows that in December 2021, EML Payments had A$86.0 million in debt, an increase from A$36.2 million, over a year. However, he has A$86.2 million in cash to offset this, resulting in net cash of A$195.0k.
How strong is EML Payments’ balance sheet?
The latest balance sheet data shows that EML Payments had liabilities of A$2.18 billion due within one year, and liabilities of A$148.2 million falling due thereafter. As compensation for these obligations, it had cash of A$86.2 million and receivables valued at A$63.3 million due within 12 months. Thus, its liabilities total A$2.17 billion more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the A$543.4 million company, like a colossus towering above mere mortals. So we definitely think shareholders need to watch this one closely. After all, EML Payments would likely need a major recapitalization if it were to pay its creditors today. EML Payments has net cash, so it’s fair to say that it doesn’t have a lot of leverage, even though it has very large liabilities, in total.
The bad news is that EML Payments has seen its EBIT drop 19% over the past year. If that kind of decline isn’t stopped, then managing his debt will be harder than selling broccoli-flavored ice cream for a bounty. The balance sheet is clearly the area to focus on when analyzing debt. But future earnings, more than anything, will determine EML Payments’ ability to maintain a healthy balance sheet in the future. So if you want to see what the pros think, you might find this free analyst earnings forecast report Be interesting.
Finally, a company can only repay its debts with cold hard cash, not with book profits. Although EML Payments has net cash on its balance sheet, it’s still worth looking at its ability to convert earnings before interest and taxes (EBIT) to free cash flow, to help us understand how quickly it’s building (or erodes) that treasury. balance. Over the past three years, EML Payments has recorded free cash flow of 36% of EBIT, which is lower than expected. It’s not great when it comes to paying off debt.
Although EML Payments’ balance sheet is not particularly strong, due to total liabilities, it is clearly positive to see that it has a net cash position of A$195,000. However, we find both the level of EML Payments’ total liabilities and its interest coverage troubling. So despite the money, we think it comes with some risk. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. Example: we have identified 4 Warning Signs for EML Payments you should be aware.
If you are interested in investing in businesses that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.