Here's Why Mare Nostrum Société anonyme (EPA:ALMAR) Has A Meaningful Debt Burden

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.' 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. Importantly, Mare Nostrum Société anonyme (EPA:ALMAR) does carry debt. But the more important question is: how much risk is that debt creating?

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. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Mare Nostrum Société anonyme

What Is Mare Nostrum Société anonyme's Net Debt?

The chart below, which you can click on for greater detail, shows that Mare Nostrum Société anonyme had €28.3m in debt in December 2021; about the same as the year before. However, because it has a cash reserve of €14.4m, its net debt is less, at about €13.8m.

How Strong Is Mare Nostrum Société anonyme's Balance Sheet?

The latest balance sheet data shows that Mare Nostrum Société anonyme had liabilities of €44.8m due within a year, and liabilities of €23.6m falling due after that. On the other hand, it had cash of €14.4m and €39.8m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €14.2m.

This deficit is considerable relative to its market capitalization of €21.4m, so it does suggest shareholders should keep an eye on Mare Nostrum Société anonyme's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). 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).

Mare Nostrum Société anonyme shareholders face the double whammy of a high net debt to EBITDA ratio (7.5), and fairly weak interest coverage, since EBIT is just 2.3 times the interest expense. The debt burden here is substantial. One redeeming factor for Mare Nostrum Société anonyme is that it turned last year's EBIT loss into a gain of €1.2m, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Mare Nostrum Société anonyme will need earnings to service that debt. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Mare Nostrum Société anonyme reported free cash flow worth 16% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

We'd go so far as to say Mare Nostrum Société anonyme's net debt to EBITDA was disappointing. Having said that, its ability to grow its EBIT isn't such a worry. Overall, we think it's fair to say that Mare Nostrum Société anonyme has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Mare Nostrum Société anonyme (of which 1 can't be ignored!) you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.