We Think Groupe MEDIA 6 (EPA:EDI) Is Taking Some Risk With Its Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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, Groupe MEDIA 6 (EPA:EDI) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Groupe MEDIA 6

How Much Debt Does Groupe MEDIA 6 Carry?

As you can see below, Groupe MEDIA 6 had €20.7m of debt at March 2022, down from €24.2m a year prior. On the flip side, it has €16.4m in cash leading to net debt of about €4.30m.

How Healthy Is Groupe MEDIA 6's Balance Sheet?

According to the last reported balance sheet, Groupe MEDIA 6 had liabilities of €30.0m due within 12 months, and liabilities of €23.6m due beyond 12 months. Offsetting these obligations, it had cash of €16.4m as well as receivables valued at €19.2m due within 12 months. So its liabilities total €18.1m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of €28.4m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). 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).

Groupe MEDIA 6 has net debt of just 0.83 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 9.1 times, which is more than adequate. Although Groupe MEDIA 6 made a loss at the EBIT level, last year, it was also good to see that it generated €2.5m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Groupe MEDIA 6 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.

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 the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Groupe MEDIA 6 saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Groupe MEDIA 6's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example, its net debt to EBITDA is relatively strong. When we consider all the factors discussed, it seems to us that Groupe MEDIA 6 is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. Case in point: We've spotted 4 warning signs for Groupe MEDIA 6 you should be aware of, and 2 of them are a bit unpleasant.

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.