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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Sigdo Koppers S.A. (SNSE:SK) does have debt on its balance sheet. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Sigdo Koppers's Net Debt?
The chart below, which you can click on for greater detail, shows that Sigdo Koppers had US$1.29b in debt in June 2022; about the same as the year before. On the flip side, it has US$299.5m in cash leading to net debt of about US$987.3m.
How Strong Is Sigdo Koppers' Balance Sheet?
According to the last reported balance sheet, Sigdo Koppers had liabilities of US$1.23b due within 12 months, and liabilities of US$1.15b due beyond 12 months. Offsetting this, it had US$299.5m in cash and US$737.2m in receivables that were due within 12 months. So it has liabilities totalling US$1.34b more than its cash and near-term receivables, combined.
When you consider that this deficiency exceeds the company's US$1.27b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Sigdo Koppers has net debt worth 2.2 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 6.9 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. It is well worth noting that Sigdo Koppers's EBIT shot up like bamboo after rain, gaining 46% in the last twelve months. That'll make it easier to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Sigdo Koppers will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
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. During the last three years, Sigdo Koppers produced sturdy free cash flow equating to 52% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
When it comes to the balance sheet, the standout positive for Sigdo Koppers was the fact that it seems able to grow its EBIT confidently. But the other factors we noted above weren't so encouraging. For example, its level of total liabilities makes us a little nervous about its debt. When we consider all the factors mentioned above, we do feel a bit cautious about Sigdo Koppers's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. Case in point: We've spotted 2 warning signs for Sigdo Koppers you should be aware of, and 1 of them is a bit concerning.
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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Sigdo Koppers S.A., together with its subsidiaries, engages in services, industrial, and commercial and automotive businesses worldwide.
The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.
|Analysis Area||Score (0-6)|
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Proven track record with mediocre balance sheet.