Is SIG Group (VTX:SIGN) A Risky Investment?

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.' 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. Importantly, SIG Group AG (VTX:SIGN) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Our analysis indicates that SIGN is potentially undervalued!

What Is SIG Group's Debt?

The image below, which you can click on for greater detail, shows that at June 2022 SIG Group had debt of €2.43b, up from €1.64b in one year. However, it does have €526.2m in cash offsetting this, leading to net debt of about €1.91b.

A Look At SIG Group's Liabilities

The latest balance sheet data shows that SIG Group had liabilities of €1.71b due within a year, and liabilities of €2.64b falling due after that. On the other hand, it had cash of €526.2m and €426.6m worth of receivables due within a year. So it has liabilities totalling €3.39b more than its cash and near-term receivables, combined.

This deficit isn't so bad because SIG Group is worth €8.15b, 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.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

SIG Group's debt is 3.6 times its EBITDA, and its EBIT cover its interest expense 6.1 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Notably SIG Group's EBIT was pretty flat over the last year. Ideally it can diminish its debt load by kick-starting earnings growth. 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 SIG Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, SIG Group actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

On our analysis SIG Group's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. For example, its net debt to EBITDA makes us a little nervous about its debt. When we consider all the elements mentioned above, it seems to us that SIG Group is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for SIG Group you should be aware of, and 1 of them is potentially serious.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.