Is ProSiebenSat.1 Media (ETR:PSM) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that ProSiebenSat.1 Media SE (ETR:PSM) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for ProSiebenSat.1 Media

What Is ProSiebenSat.1 Media's Debt?

The chart below, which you can click on for greater detail, shows that ProSiebenSat.1 Media had €3.19b in debt in December 2020; about the same as the year before. On the flip side, it has €1.26b in cash leading to net debt of about €1.93b.

How Healthy Is ProSiebenSat.1 Media's Balance Sheet?

We can see from the most recent balance sheet that ProSiebenSat.1 Media had liabilities of €1.98b falling due within a year, and liabilities of €3.42b due beyond that. On the other hand, it had cash of €1.26b and €624.0m worth of receivables due within a year. So its liabilities total €3.51b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of €4.10b, so it does suggest shareholders should keep an eye on ProSiebenSat.1 Media's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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).

With a debt to EBITDA ratio of 2.4, ProSiebenSat.1 Media uses debt artfully but responsibly. And the fact that its trailing twelve months of EBIT was 7.6 times its interest expenses harmonizes with that theme. Shareholders should be aware that ProSiebenSat.1 Media's EBIT was down 28% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if ProSiebenSat.1 Media can strengthen its balance sheet over time. 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. Looking at the most recent three years, ProSiebenSat.1 Media recorded free cash flow of 42% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Mulling over ProSiebenSat.1 Media's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Looking at the bigger picture, it seems clear to us that ProSiebenSat.1 Media's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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 4 warning signs for ProSiebenSat.1 Media you should be aware of.

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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