These 4 Measures Indicate That Lotus Bakeries (EBR:LOTB) Is Using Debt Reasonably Well

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Lotus Bakeries NV (EBR:LOTB) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Lotus Bakeries

What Is Lotus Bakeries's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Lotus Bakeries had €260.8m of debt, an increase on €231.3m, over one year. However, it also had €91.1m in cash, and so its net debt is €169.8m.

How Healthy Is Lotus Bakeries' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Lotus Bakeries had liabilities of €219.1m due within 12 months and liabilities of €286.8m due beyond that. Offsetting these obligations, it had cash of €91.1m as well as receivables valued at €123.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €291.7m.

Of course, Lotus Bakeries has a market capitalization of €4.13b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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.

Lotus Bakeries's net debt is only 1.1 times its EBITDA. And its EBIT covers its interest expense a whopping 46.4 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Fortunately, Lotus Bakeries grew its EBIT by 6.4% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Lotus Bakeries'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, Lotus Bakeries recorded free cash flow of 48% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

The good news is that Lotus Bakeries's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And we also thought its net debt to EBITDA was a positive. Taking all this data into account, it seems to us that Lotus Bakeries takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. Over time, share prices tend to follow earnings per share, so if you're interested in Lotus Bakeries, you may well want to click here to check an interactive graph of its earnings per share history.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 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.