Warren Buffett said: “Volatility is far from synonymous with risk. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We note that Adecco Group SA (VTX:ADEN) has debt on its balance sheet. But does this debt worry shareholders?
What risk does debt carry?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. 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. When we think about a company’s use of debt, we first look at cash and debt together.
Check out our latest analysis for Adecco Group
What is the debt of the Adecco group?
You can click on the graph below for historical figures, but it shows that in March 2022 the Adecco Group had 3.57 billion euros in debt, an increase from 1.84 billion euros, over a year. On the other hand, he has €1.07 billion in cash, which results in a net debt of around €2.49 billion.
How healthy is the Adecco Group’s balance sheet?
The latest balance sheet data shows that the Adecco Group had liabilities of 5.31 billion euros due within the year, and liabilities of 3.80 billion euros due thereafter. On the other hand, it had cash of 1.07 billion euros and 4.47 billion euros in receivables at less than one year. Thus, its liabilities total 3.56 billion euros more than the combination of its cash and short-term receivables.
This deficit is considerable compared to its market capitalization of 5.83 billion euros, so it suggests that shareholders monitor the use of debt by the Adecco group. If its lenders asked it to shore up its balance sheet, shareholders would likely face significant dilution.
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). Thus, we consider debt to earnings with and without amortization and depreciation expense.
The Adecco Group has a debt to EBITDA ratio of 2.6, which signals significant debt, but is still quite reasonable for most types of businesses. But its EBIT was around 22.0 times its interest expense, implying that the company isn’t really paying a high cost to maintain that level of leverage. Even if the low cost turns out to be unsustainable, that’s a good sign. One way for the Adecco Group to overcome its debt would be to stop borrowing more but continue to grow EBIT by around 12%, as it did last year. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine the Adecco Group’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, the Adecco Group has produced strong free cash flow equivalent to 74% of its EBIT, which is what we expected. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
Fortunately, the Adecco Group’s impressive interest coverage means it has the upper hand on its debt. But truth be told, we think his total passive level undermines that impression a bit. Looking at all of the above factors together, it seems to us that the Adecco Group can manage its debt quite comfortably. On the plus side, this leverage can increase shareholder returns, but the potential downside is greater risk of loss, so it’s worth keeping an eye on the balance sheet. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. We have identified 3 warning signs with Adecco Group (at least 1 that should not be ignored), 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.
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