Is Sopra Steria Group (EPA:SOP) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Sopra Steria Group SA (EPA:SOP) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Sopra Steria Group

How Much Debt Does Sopra Steria Group Carry?

As you can see below, Sopra Steria Group had €544.5m of debt at December 2021, down from €671.1m a year prior. However, it also had €217.2m in cash, and so its net debt is €327.3m.

How Strong Is Sopra Steria Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sopra Steria Group had liabilities of €1.90b due within 12 months and liabilities of €1.18b due beyond that. On the other hand, it had cash of €217.2m and €1.34b worth of receivables due within a year. So its liabilities total €1.52b more than the combination of its cash and short-term receivables.

Sopra Steria Group has a market capitalization of €3.28b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Sopra Steria Group has a low net debt to EBITDA ratio of only 0.74. And its EBIT covers its interest expense a whopping 23.0 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Sopra Steria Group grew its EBIT by 31% over the last twelve months, and that growth will make it easier to handle its debt. 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 Sopra Steria 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Sopra Steria 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

Sopra Steria Group's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its level of total liabilities does undermine this impression a bit. Zooming out, Sopra Steria Group seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. 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. To that end, you should be aware of the 1 warning sign we've spotted with Sopra Steria Group .

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.