Here’s why Prysmian (BIT:PRY) can manage its debt responsibly
David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. 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 note that Prysmian Spa (BIT:PRY) has debt on its balance sheet. But should shareholders worry about its use of debt?
Why is debt risky?
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. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, many companies use debt to finance their growth, without any negative consequences. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
Check out our latest analysis for Prysmian
What is Prysmian’s debt?
As you can see below, at the end of December 2021, Prysmian had 3.73 billion euros in debt, compared to 3.01 billion euros a year ago. Click on the image for more details. On the other hand, it has €1.96 billion in cash, which results in a net debt of around €1.77 billion.
How healthy is Prysmian’s balance sheet?
According to the latest published balance sheet, Prysmian had liabilities of €5.61 billion due within 12 months and liabilities of €3.32 billion due beyond 12 months. On the other hand, it had 1.96 billion euros in cash and 2.25 billion euros in receivables at less than one year. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables by €4.72 billion.
This deficit is considerable compared to its market capitalization of 7.77 billion euros, so he suggests that shareholders monitor Prysmian’s use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Prysmian’s net debt is at a very reasonable 2.3 times its EBITDA, while its EBIT covered its interest charges at just 4.4 times last year. While these numbers don’t alarm us, it’s worth noting that the cost of corporate debt has a real impact. Notably, Prysmian’s EBIT was rather stable over the past year. We would prefer to see some earnings growth as this always helps reduce debt. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Prysmian can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, while the taxman may love accounting profits, lenders only accept cash. We therefore always check how much of this EBIT is converted into free cash flow. Fortunately for all shareholders, Prysmian has actually produced more free cash flow than EBIT over the past three years. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our point of view
On the balance sheet, the most notable positive for Prysmian is the fact that it appears to be able to convert EBIT to free cash flow with confidence. But the other factors we noted above weren’t so encouraging. For example, his level of total liabilities makes us a little nervous about his debt. Looking at all this data, we feel a bit cautious about Prysmian’s debt levels. While we understand that debt can improve returns on equity, we suggest shareholders keep a close eye on their level of debt, lest it increase. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. We have identified 2 warning signs with Prysmian, and understanding them should be part of your investment process.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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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.