David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Spire Inc. (NYSE:SR) makes use of debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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 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.
How Much Debt Does Spire Carry?
The image below, which you can click on for greater detail, shows that at June 2020 Spire had debt of US$2.96b, up from US$2.64b in one year. Net debt is about the same, since the it doesn’t have much cash.
How Healthy Is Spire’s Balance Sheet?
The latest balance sheet data shows that Spire had liabilities of US$1.11b due within a year, and liabilities of US$4.16b falling due after that. On the other hand, it had cash of US$7.40m and US$258.6m worth of receivables due within a year. So its liabilities total US$5.0b more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the US$2.97b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Spire would probably need a major re-capitalization if its creditors were to demand repayment.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Spire has a rather high debt to EBITDA ratio of 5.8 which suggests a meaningful debt load. However, its interest coverage of 3.0 is reasonably strong, which is a good sign. Notably, Spire’s EBIT was pretty flat over the last year, which isn’t ideal given the debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Spire’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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Spire burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
On the face of it, Spire’s conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to grow its EBIT isn’t such a worry. We should also note that Gas Utilities industry companies like Spire commonly do use debt without problems. Taking into account all the aforementioned factors, it looks like Spire has too much debt. While some investors love that sort of risky play, it’s certainly not our cup of tea. There’s no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet – far from it. For example, we’ve discovered 5 warning signs for Spire (1 is concerning!) that you should be aware of before investing here.
At the end of the day, it’s often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It’s free.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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