The external fund manager backed by Berkshire Hathaway’s Charlie Munger, Li Lu, makes no bones about it when he says ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.’ 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, Buzzi Unicem S.p.A. (BIT:BZU) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Buzzi Unicem
What Is Buzzi Unicem’s Debt?
You can click the graphic below for the historical numbers, but it shows that Buzzi Unicem had €1.28b of debt in December 2018, down from €1.60b, one year before. However, it does have €440.5m in cash offsetting this, leading to net debt of about €834.6m.
How Healthy Is Buzzi Unicem’s Balance Sheet?
According to the last reported balance sheet, Buzzi Unicem had liabilities of €770.9m due within 12 months, and liabilities of €1.76b due beyond 12 months. Offsetting these obligations, it had cash of €440.5m as well as receivables valued at €486.3m due within 12 months. So it has liabilities totalling €1.60b more than its cash and near-term receivables, combined.
This deficit isn’t so bad because Buzzi Unicem is worth €3.59b, 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.
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Buzzi Unicem has net debt of just 1.5 times EBITDA, indicating that it is certainly not a reckless borrower. And this view is supported by the solid interest coverage, with EBIT coming in at 8.8 times the interest expense over the last year. Unfortunately, Buzzi Unicem saw its EBIT slide 4.1% in the last twelve months. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Buzzi Unicem’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 report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it’s worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, Buzzi Unicem recorded free cash flow of 37% of its EBIT, which is weaker than we’d expect. That’s not great, when it comes to paying down debt.
Our View
Neither Buzzi Unicem’s ability to grow its EBIT nor its conversion of EBIT to free cash flow gave us confidence in its ability to take on more debt. But it seems to be able to cover its interest expense with its EBIT without much trouble. Looking at all the angles mentioned above, it does seem to us that Buzzi Unicem is a somewhat risky investment as a result of its debt. That’s not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you’ve also come to that realization, you’re in luck, because today you can view this interactive graph of Buzzi Unicem’s earnings per share history for free.
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.
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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. Thank you for reading.