Here's Why Snam (BIT:SRG) Has A Meaningful Debt Burden

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Snam S.p.A. (BIT:SRG) makes use of debt. But is this debt a concern to shareholders?

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. 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, 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 Snam

How Much Debt Does Snam Carry?

You can click the graphic below for the historical numbers, but it shows that Snam had €12.9b of debt in September 2022, down from €15.7b, one year before. However, because it has a cash reserve of €1.87b, its net debt is less, at about €11.1b.

A Look At Snam's Liabilities

We can see from the most recent balance sheet that Snam had liabilities of €969.0m falling due within a year, and liabilities of €13.0b due beyond that. On the other hand, it had cash of €1.87b and €3.19b worth of receivables due within a year. So its liabilities total €8.89b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Snam is worth a massive €15.5b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Snam has a debt to EBITDA ratio of 4.9, which signals significant debt, but is still pretty reasonable for most types of business. However, its interest coverage of 12.1 is very high, suggesting that the interest expense on the debt is currently quite low. Unfortunately, Snam saw its EBIT slide 3.4% in the last twelve months. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Snam's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Snam produced sturdy free cash flow equating to 52% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Snam's net debt to EBITDA and level of total liabilities definitely weigh on it, in our esteem. But its interest cover tells a very different story, and suggests some resilience. We should also note that Gas Utilities industry companies like Snam commonly do use debt without problems. Looking at all the angles mentioned above, it does seem to us that Snam 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. 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. Case in point: We've spotted 3 warning signs for Snam you should be aware of.

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.