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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 seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Like many other companies S&T SA (ETR: SANT) uses debt. But should shareholders be concerned 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. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. Of course, many companies use debt to finance their growth without negative consequences. The first step in examining a business’s debt levels is to consider its cash flow and debt together.
Check out our latest analysis for S&T
What is S & T’s debt?
You can click on the graph below for the historical figures, but it shows that as of September 2021, S&T had a debt of 306.0 million euros, an increase from 263.6 million euros, over a year. However, because it has a cash reserve of € 230.3 million, its net debt is lower, at around € 75.7 million.
How healthy is the S&T track record?
The latest balance sheet data shows that S&T had debts of € 463.6 million maturing within one year, and debts of € 365.3 million maturing thereafter. On the other hand, it had cash of € 230.3 million and € 291.7 million in receivables within one year. Its liabilities therefore amount to € 306.9 million more than the combination of its cash and short-term receivables.
S&T has a market capitalization of 1.23 billion euros, so it could most likely raise funds to improve its balance sheet, should the need arise. But it is clear that it is absolutely necessary to take a close look at whether it can manage its debt without dilution.
We measure a company’s indebtedness relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating the ease with which its earnings before interest and taxes (EBIT ) covers its interests. costs (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).
Looking at its 0.88 net debt over EBITDA and 6.4 times interest coverage, it seems to us that S&T is probably using debt in a fairly reasonable way. We therefore recommend that you keep a close eye on the impact of financing costs on the business. But the other side of the story is that S&T has seen its EBIT drop 6.9% in the past year. If profits continue to decline at this rate, the company may find it increasingly difficult to manage debt. When analyzing debt levels, the balance sheet is the obvious place to start. But ultimately, the company’s future profitability will decide whether S&T can strengthen its balance sheet over time. So, if you want to see what the professionals think, you might find this free Analyst Profit Forecast report interesting.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, S&T has recorded free cash flow of approximately 94% of its EBIT, which is higher than what we usually expected. This puts him in a very strong position to pay off the debt.
Our point of view
The good news is that S & T’s demonstrated ability to convert EBIT into free cash flow delights us like a fluffy puppy does a toddler. But, on a darker note, we’re a little concerned about its EBIT growth rate. Looking at all of the above factors together, it seems to us that S&T can manage its debt quite comfortably. Of course, while this leverage can improve returns on equity, it comes with more risk, so it’s worth keeping an eye out for. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. For example – S&T has 1 warning sign we think you should be aware.
At the end of the day, it’s often best to focus on businesses that don’t have net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
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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 any stock 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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