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 risk.” 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 note that Atos SE (EPA: ATO) has debt on its balance sheet. But the real question is whether this debt makes the business risky.
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. If things really go wrong, lenders can take over the business. However, a more common (but still painful) scenario is that he must raise new equity at low cost, thereby diluting shareholders over the long term. Of course, many companies use debt to finance their growth without negative consequences. When we look at debt levels, we first consider both liquidity and debt levels.
Check out our latest analysis for Atos
What is Atos’ net debt?
As you can see below, Atos had € 3.61 billion in debt in June 2021, up from € 4.04 billion the year before. On the other hand, it has 2.48 billion euros of liquidity leading to a net debt of about 1.13 billion euros.
How strong is Atos’ balance sheet?
The latest balance sheet data shows Atos owed € 6.22 billion in debt due within one year, and € 4.46 billion in debt maturing thereafter. In compensation for these commitments, it had cash of € 2.48 billion as well as receivables valued at € 3.57 billion maturing in 12 months. Its liabilities therefore amount to € 4.63 billion more than the combination of its cash and short-term receivables.
Given that this deficit is actually greater than the company’s market cap of 4.61 billion euros, we think shareholders should really watch Atos’ debt levels, like a parent watching their child. riding a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely that shareholders would suffer a significant dilution.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Atos’ net debt is only 1.0 times its EBITDA. And its EBIT covers its interest costs 13.3 times more. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. In fact, Atos’ saving grace is its low level of debt, as its EBIT has fallen 31% in the past twelve months. When a business sees its profits accumulate, it can sometimes see its relationship with its lenders deteriorate. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future profits, more than anything, that will determine Atos’ ability to maintain a healthy balance sheet going forward. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years Atos has generated free cash flow of 85% of its EBIT, more than we expected. This puts him in a very strong position to pay off the debt.
Our point of view
As Atos’ EBIT growth rate makes us nervous. For example, its interest coverage and the conversion of EBIT to free cash flow give us some confidence in its ability to manage its debt. We think Atos’ debt makes it a bit risky, having considered the aforementioned data points together. This isn’t necessarily a bad thing, as leverage can increase returns on equity, but it’s something to be aware of. 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. We have identified 5 warning signs with Atos and understanding them should be part of your investment process.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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