Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital”. 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. We can see that Temenos AG (VTX: TEMN) uses debt in his business. But should shareholders be worried about its use of debt?

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. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still painful) scenario is that he must raise new equity at low cost, thereby diluting shareholders over the long term. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.

See our latest review for Temenos

What is Temenos’ net debt?

You can click on the graph below for historical figures, but it shows Temenos owed US $ 881.7 million in debt as of March 2021, up from US $ 1.11 billion a year earlier. On the other hand, it has $ 65.9 million in cash, resulting in net debt of around $ 815.8 million.

A look at the responsibilities of Temenos

According to the latest published balance sheet, Temenos had liabilities of US $ 596.1 million due within 12 months and liabilities of US $ 1.03 billion due beyond 12 months. On the other hand, he had $ 65.9 million in cash and $ 332.6 million in receivables due within one year. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by US $ 1.23 billion.

Of course, Temenos has a titanic market cap of $ 11.7 billion, so those liabilities are likely manageable. Having said that, it is clear that we must continue to monitor his record lest it get worse.

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

With a net debt to EBITDA of 3.0, Temenos has quite a significant amount of debt. But the high interest coverage of 9.8 suggests he can easily pay off that debt. We have seen Temenos increase its EBIT by 8.7% over the past twelve months. While this hardly strikes us, it is a bright spot when it comes to debt. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Temenos can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.

Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Temenos has actually generated more free cash flow than EBIT. There is nothing better than cash flow to stay in the good graces of your lenders.

Our point of view

Temenos’ EBIT conversion into free cash flow suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. But frankly, we think its net debt to EBITDA undermines that impression a bit. When we consider the range of factors above, it looks like Temenos is pretty reasonable with its use of debt. While this carries some risk, it can also improve returns for shareholders. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we have identified 1 warning sign for Temenos that you should be aware of.

Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash growth stocks today.

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