These 4 Measures Indicate That Snam (BIT:SRG) Is Using Debt Extensively

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Snam S.p.A. (BIT:SRG) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Snam

What Is Snam's Net Debt?

As you can see below, Snam had €15.7b of debt, at June 2021, which is about the same as the year before. You can click the chart for greater detail. However, it also had €1.63b in cash, and so its net debt is €14.1b.

How Healthy Is Snam's Balance Sheet?

According to the last reported balance sheet, Snam had liabilities of €5.50b due within 12 months, and liabilities of €10.5b due beyond 12 months. Offsetting these obligations, it had cash of €1.63b as well as receivables valued at €5.00m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €14.3b.

This deficit is considerable relative to its very significant market capitalization of €16.7b, so it does suggest shareholders should keep an eye on Snam's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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

As it happens Snam has a fairly concerning net debt to EBITDA ratio of 6.3 but very strong interest coverage of 17.0. So either it has access to very cheap long term debt or that interest expense is going to grow! Notably Snam's EBIT was pretty flat over the last year. Ideally it can diminish its debt load by kick-starting earnings growth. 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 Snam can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Snam created free cash flow amounting to 18% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

We'd go so far as to say Snam's net debt to EBITDA was disappointing. But on the bright side, its interest cover is a good sign, and makes us more optimistic. It's also worth noting that Snam is in the Gas Utilities industry, which is often considered to be quite defensive. Once we consider all the factors above, together, it seems to us that Snam's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with Snam (including 1 which makes us a bit uncomfortable) .

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.

If you decide to trade Snam, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.