We Think STEF (EPA:STF) Is Taking Some Risk With Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 STEF SA (EPA:STF) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for STEF

How Much Debt Does STEF Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2022 STEF had €927.2m of debt, an increase on €798.6m, over one year. However, it also had €87.6m in cash, and so its net debt is €839.6m.

How Healthy Is STEF's Balance Sheet?

The latest balance sheet data shows that STEF had liabilities of €1.52b due within a year, and liabilities of €789.5m falling due after that. On the other hand, it had cash of €87.6m and €879.8m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €1.34b.

When you consider that this deficiency exceeds the company's €1.31b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive 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).

STEF's net debt is 2.6 times its EBITDA, which is a significant but still reasonable amount of leverage. But its EBIT was about 18.1 times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. One way STEF could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 11%, as it did over the last year. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if STEF 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 company can only pay off debt with cold hard cash, not accounting profits. 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, STEF produced sturdy free cash flow equating to 51% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

STEF's level of total liabilities and net debt to EBITDA definitely weigh on it, in our esteem. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. Looking at all the angles mentioned above, it does seem to us that STEF is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. Be aware that STEF is showing 2 warning signs in our investment analysis , you should know about...

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.

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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.