SIG (LON:SHI) Seems To Be Using A Lot Of Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, SIG plc (LON:SHI) does carry debt. But should shareholders be worried about its use of debt?

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When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

What Is SIG's Debt?

As you can see below, SIG had UK£263.5m of debt, at December 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had UK£87.4m in cash, and so its net debt is UK£176.1m.

How Strong Is SIG's Balance Sheet?

The latest balance sheet data shows that SIG had liabilities of UK£439.3m due within a year, and liabilities of UK£559.1m falling due after that. On the other hand, it had cash of UK£87.4m and UK£283.9m worth of receivables due within a year. So its liabilities total UK£627.1m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the UK£123.9m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, SIG would likely require a major re-capitalisation if it had to pay its creditors today.

Check out our latest analysis for SIG

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While SIG's debt to EBITDA ratio (4.9) suggests that it uses some debt, its interest cover is very weak, at 0.55, suggesting high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Even worse, SIG saw its EBIT tank 51% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. 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 SIG can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, SIG actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

To be frank both SIG's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. We're quite clear that we consider SIG to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. Given the risks around SIG's use of debt, the sensible thing to do is to check if insiders have been unloading the stock.

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.