These 4 Measures Indicate That Criteo (NASDAQ:CRTO) Is Using Debt Safely

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Criteo S.A. (NASDAQ:CRTO) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Criteo

How Much Debt Does Criteo Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2019 Criteo had US$3.76m of debt, an increase on US$5.3, over one year. However, it does have US$409.2m in cash offsetting this, leading to net cash of US$405.4m.

NasdaqGS:CRTO Historical Debt, January 27th 2020
NasdaqGS:CRTO Historical Debt, January 27th 2020

A Look At Criteo's Liabilities

Zooming in on the latest balance sheet data, we can see that Criteo had liabilities of US$528.4m due within 12 months and liabilities of US$159.1m due beyond that. Offsetting this, it had US$409.2m in cash and US$435.7m in receivables that were due within 12 months. So it can boast US$157.4m more liquid assets than total liabilities.

This surplus suggests that Criteo is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Criteo boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Criteo saw its EBIT decline by 7.1% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Criteo can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Criteo has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Criteo recorded free cash flow worth a fulsome 93% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Criteo has net cash of US$405.4m, as well as more liquid assets than liabilities. The cherry on top was that in converted 93% of that EBIT to free cash flow, bringing in US$150m. So is Criteo's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Criteo that you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

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