These 4 Measures Indicate That Sláturfélags Suðurlands svf (ICE:SFS B) Is Using Debt In A Risky Way

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Sláturfélags Suðurlands svf. (ICE:SFS B) does use debt in its business. But is this debt a concern to shareholders?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Sláturfélags Suðurlands svf

What Is Sláturfélags Suðurlands svf's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 Sláturfélags Suðurlands svf had Kr2.19b of debt, an increase on Kr2.03b, over one year. However, because it has a cash reserve of Kr45.6m, its net debt is less, at about Kr2.15b.

A Look At Sláturfélags Suðurlands svf's Liabilities

The latest balance sheet data shows that Sláturfélags Suðurlands svf had liabilities of Kr1.69b due within a year, and liabilities of Kr3.15b falling due after that. Offsetting these obligations, it had cash of Kr45.6m as well as receivables valued at Kr1.78b due within 12 months. So its liabilities total Kr3.01b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the Kr645.6m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Sláturfélags Suðurlands svf 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).

While we wouldn't worry about Sláturfélags Suðurlands svf's net debt to EBITDA ratio of 3.6, we think its super-low interest cover of 0.86 times is a sign of high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Worse, Sláturfélags Suðurlands svf's EBIT was down 63% over the last year. 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 you can't view debt in total isolation; since Sláturfélags Suðurlands svf will need earnings to service that debt. 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, 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, Sláturfélags Suðurlands svf burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Sláturfélags Suðurlands svf's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And furthermore, its interest cover also fails to instill confidence. It looks to us like Sláturfélags Suðurlands svf carries a significant balance sheet burden. If you harvest honey without a bee suit, you risk getting stung, so we'd probably stay away from this particular stock. The balance sheet is clearly the area to focus on when you are analysing debt. 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 4 warning signs for Sláturfélags Suðurlands svf you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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