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 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 Société Anonyme Belge de Constructions Aéronautiques (EBR:SAB) makes use of debt. But is this debt a concern to shareholders?
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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company’s debt levels is to consider its cash and debt together.
How Much Debt Does Société Anonyme Belge de Constructions Aéronautiques Carry?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Société Anonyme Belge de Constructions Aéronautiques had €139.5m of debt, an increase on €126, over one year. On the flip side, it has €85.7m in cash leading to net debt of about €53.8m.
How Healthy Is Société Anonyme Belge de Constructions Aéronautiques’s Balance Sheet?
The latest balance sheet data shows that Société Anonyme Belge de Constructions Aéronautiques had liabilities of €65.5m due within a year, and liabilities of €179.5m falling due after that. Offsetting this, it had €85.7m in cash and €63.9m in receivables that were due within 12 months. So its liabilities total €95.4m more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the €49.9m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Société Anonyme Belge de Constructions Aéronautiques would probably need a major re-capitalization if its creditors were to demand repayment.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Société Anonyme Belge de Constructions Aéronautiques’s debt is 4.0 times its EBITDA, and its EBIT cover its interest expense 5.9 times over. This suggests that while the debt levels are significant, we’d stop short of calling them problematic. Notably, Société Anonyme Belge de Constructions Aéronautiques made a loss at the EBIT level, last year, but improved that to positive EBIT of €6.6m in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Société Anonyme Belge de Constructions Aéronautiques’s earnings that will influence how the balance sheet holds up in the future. So if you’re keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
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 the earnings before interest and tax (EBIT) is backed by free cash flow. Looking at the most recent year, Société Anonyme Belge de Constructions Aéronautiques recorded free cash flow of 35% of its EBIT, which is weaker than we’d expect. That weak cash conversion makes it more difficult to handle indebtedness.
We’d go so far as to say Société Anonyme Belge de Constructions Aéronautiques’s level of total liabilities was disappointing. Having said that, its ability to cover its interest expense with its EBIT isn’t such a worry. Overall, it seems to us that Société Anonyme Belge de Constructions Aéronautiques’s balance sheet is really quite a risk to the business. For this reason we’re pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet – far from it. Like risks, for instance. Every company has them, and we’ve spotted 2 warning signs for Société Anonyme Belge de Constructions Aéronautiques (of which 1 doesn’t sit too well with us!) you should know about.
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
If you spot an error that warrants correction, please contact the editor at email@example.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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