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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, ADVA Optical Networking SE (ETR:ADV) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for ADVA Optical Networking
What Is ADVA Optical Networking's Debt?
You can click the graphic below for the historical numbers, but it shows that ADVA Optical Networking had €80.1m of debt in June 2019, down from €96.3m, one year before. However, because it has a cash reserve of €49.4m, its net debt is less, at about €30.7m.
How Strong Is ADVA Optical Networking's Balance Sheet?
The latest balance sheet data shows that ADVA Optical Networking had liabilities of €152.1m due within a year, and liabilities of €119.1m falling due after that. Offsetting these obligations, it had cash of €49.4m as well as receivables valued at €106.1m due within 12 months. So its liabilities total €115.6m more than the combination of its cash and short-term receivables.
This deficit isn't so bad because ADVA Optical Networking is worth €321.5m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.