Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Flour Mills C. Sarantopoulos S.A. (ATH:KYSA) makes use of debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 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, 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.
What Is Flour Mills C. Sarantopoulos's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2020 Flour Mills C. Sarantopoulos had €12.6m of debt, an increase on €10.7m, over one year. Net debt is about the same, since the it doesn't have much cash.
How Healthy Is Flour Mills C. Sarantopoulos's Balance Sheet?
According to the last reported balance sheet, Flour Mills C. Sarantopoulos had liabilities of €17.8m due within 12 months, and liabilities of €2.55m due beyond 12 months. Offsetting these obligations, it had cash of €205.1k as well as receivables valued at €5.98m due within 12 months. So its liabilities total €14.2m more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the €5.44m 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. At the end of the day, Flour Mills C. Sarantopoulos would probably need a major re-capitalization if its creditors were to demand repayment.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Flour Mills C. Sarantopoulos shareholders face the double whammy of a high net debt to EBITDA ratio (10.6), and fairly weak interest coverage, since EBIT is just 0.91 times the interest expense. The debt burden here is substantial. Fortunately, Flour Mills C. Sarantopoulos grew its EBIT by 8.0% in the last year, slowly shrinking its debt relative to earnings. When analysing debt levels, the balance sheet is the obvious place to start. But it is Flour Mills C. Sarantopoulos's earnings that will influence how the balance sheet holds up in the future. 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, 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, Flour Mills C. Sarantopoulos recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
To be frank both Flour Mills C. Sarantopoulos's interest cover 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 growing its EBIT; that's encouraging. After considering the datapoints discussed, we think Flour Mills C. Sarantopoulos has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider risks, for instance. Every company has them, and we've spotted 2 warning signs for Flour Mills C. Sarantopoulos you should know about.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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