Talgo (BME: TLGO) takes risks with his use of debt

Howard Marks put it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried. So it can be obvious that you need to consider debt, when you think about how risky a given stock is, because too much debt can sink a business. Like many other companies Talgo, SA (BME: TLGO) uses debt. But does this debt concern shareholders?

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. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution of a business with the ability to reinvest at high rates of return. The first step in examining a company’s debt levels is to consider its cash flow and debt together.

Check out our latest analysis for Talgo

What is Talgo’s net debt?

The image below, which you can click for more details, shows that in June 2021 Talgo had a debt of 316.5 million euros, compared to 295.3 million euros in one year. However, he has € 218.2 million in cash offsetting this, which leads to net debt of around € 98.2 million.

BME: TLGO Debt to equity history November 30, 2021

Is Talgo’s track record healthy?

We can see from the most recent balance sheet that Talgo had a liability of € 321.6 million maturing within one year and a liability of € 354.5 million beyond. On the other hand, it had cash of € 218.2 million and € 317.2 million in receivables within one year. Its liabilities therefore amount to € 140.6 million more than the combination of its cash and short-term receivables.

This deficit is not that serious as Talgo is worth € 580.2m, and could therefore probably raise enough capital to consolidate its balance sheet, should the need arise. But we absolutely want to keep our eyes open for indications that its debt is too risky.

In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).

Talgo’s debt is 3.0 times its EBITDA, and its EBIT covers its interest expense 5.6 times. Overall, this implies that while we wouldn’t like to see debt levels rise, we believe it can handle its current leverage. We note that Talgo has increased its EBIT by 25% over the past year, which should make it easier to repay debt in the future. When analyzing debt levels, the balance sheet is the obvious starting point. But it’s future earnings, more than anything, that will determine Talgo’s 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, while the IRS may love accounting profits, lenders only accept hard cash. We must therefore clearly examine whether this EBIT leads to the corresponding free cash flow. Over the past three years, Talgo has spent a lot of money. While investors no doubt expect this situation to turn around in due course, this clearly means that its use of debt is riskier.

Our point of view

Talgo’s struggle to convert EBIT to free cash flow made us guess at the strength of its balance sheet, but the other data points we considered were relatively interesting. For example, its EBIT growth rate was refreshing. We think Talgo’s debt makes him a bit risky, having looked at the aforementioned data points together. Not all risks are bad, as they can increase stock returns if they are profitable, but this risk of leverage is worth keeping in mind. On top of most other metrics, we think it’s important to track how quickly earnings per share are growing, if at all. If you have understood this as well, you are in luck because today you can check out this interactive graph of historical Talgo earnings per share for free.

If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash net growth stocks.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.

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