Is Aroundtown (ETR:AT1) using too much debt?

Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Like many other companies Around town SA (ETR:AT1) uses debt. But the real question is whether this debt makes the business risky.

When is debt a problem?

Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. 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.

See our latest analysis for Aroundtown

What is Aroundtown’s net debt?

As you can see below, at the end of December 2021, Aroundtown had 15.6 billion euros in debt, compared to 11.9 billion euros a year ago. Click on the image for more details. However, because it has a cash reserve of 3.21 billion euros, its net debt is less, at around 12.4 billion euros.

XTRA:AT1 Debt to Equity May 13, 2022

How strong is Aroundtown’s balance sheet?

According to the last published balance sheet, Aroundtown had liabilities of €1.61 ​​billion maturing within 12 months and liabilities of €18.6 billion maturing beyond 12 months. On the other hand, it had cash of 3.21 billion euros and 534.2 million euros in receivables at less than one year. It therefore has liabilities totaling 16.5 billion euros more than its cash and short-term receivables, combined.

This deficit casts a shadow over the 5.02 billion euro company, like a colossus towering above mere mortals. So we definitely think shareholders need to watch this one closely. Ultimately, Aroundtown would likely need a major recapitalization if its creditors were to demand repayment.

We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). Thus, we consider debt to earnings with and without amortization and depreciation expense.

Aroundtown has a fairly high debt-to-EBITDA ratio of 11.6, suggesting significant leverage. However, its interest coverage of 5.8 is reasonably strong, which is a good sign. Aroundtown has increased its EBIT by 5.0% over the past year. It’s far from amazing, but it’s a good thing when it comes to paying down debt. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Aroundtown 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. Over the past three years, Aroundtown has recorded free cash flow of 61% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This free cash flow puts the company in a good position to repay its debt, should it arise.

Our point of view

At first glance, Aroundtown’s net debt to EBITDA left us wondering about the stock, and its level of total liabilities was no more appealing than the single empty restaurant on the busiest night of the year. But at least it’s decent enough to convert EBIT to free cash flow; it’s encouraging. Looking at the big picture, it seems clear to us that Aroundtown’s use of debt creates risks for the business. If all goes well, this should boost returns, but on the other hand, the risk of permanent capital loss is increased by debt. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. We have identified 3 warning signs with Aroundtown (at least 1 that should not be ignored), and understanding them should be part of your investment process.

If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.

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.

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John A. Bogar