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. We note that The House of Agriculture Spiroy S.A. (ATH:SPIR) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is House of Agriculture Spiroy's Net Debt?
The image below, which you can click on for greater detail, shows that at June 2021 House of Agriculture Spiroy had debt of €17.2m, up from €15.8m in one year. On the flip side, it has €1.36m in cash leading to net debt of about €15.8m.
How Healthy Is House of Agriculture Spiroy's Balance Sheet?
We can see from the most recent balance sheet that House of Agriculture Spiroy had liabilities of €26.5m falling due within a year, and liabilities of €3.52m due beyond that. On the other hand, it had cash of €1.36m and €4.97m worth of receivables due within a year. So its liabilities total €23.7m more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the €6.23m 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, House of Agriculture Spiroy would probably need a major re-capitalization if its creditors were to demand repayment.
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). 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).
House of Agriculture Spiroy shareholders face the double whammy of a high net debt to EBITDA ratio (10.2), and fairly weak interest coverage, since EBIT is just 0.50 times the interest expense. The debt burden here is substantial. One redeeming factor for House of Agriculture Spiroy is that it turned last year's EBIT loss into a gain of €624k, over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is House of Agriculture Spiroy's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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, House of Agriculture Spiroy saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
To be frank both House of Agriculture Spiroy's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. Having said that, its ability to grow its EBIT isn't such a worry. We think the chances that House of Agriculture Spiroy has too much debt a very significant. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for House of Agriculture Spiroy (of which 2 don't sit too well with us!) you should know about.
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.
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.
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