Here's Why Spark New Zealand (NZSE:SPK) 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. We note that Spark New Zealand Limited (NZSE:SPK) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

Check out our latest analysis for Spark New Zealand

How Much Debt Does Spark New Zealand Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Spark New Zealand had debt of NZ$1.63b, up from NZ$1.07b in one year. On the flip side, it has NZ$59.0m in cash leading to net debt of about NZ$1.57b.

How Strong Is Spark New Zealand's Balance Sheet?

The latest balance sheet data shows that Spark New Zealand had liabilities of NZ$1.06b due within a year, and liabilities of NZ$1.99b falling due after that. Offsetting this, it had NZ$59.0m in cash and NZ$739.0m in receivables that were due within 12 months. So it has liabilities totalling NZ$2.25b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Spark New Zealand is worth NZ$5.62b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). 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).

Spark New Zealand has net debt worth 1.7 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 5.6 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Importantly, Spark New Zealand's EBIT fell a jaw-dropping 50% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 Spark New Zealand can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Spark New Zealand recorded free cash flow of 35% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Mulling over Spark New Zealand's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But at least its net debt to EBITDA is not so bad. Once we consider all the factors above, together, it seems to us that Spark New Zealand's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. For example Spark New Zealand has 3 warning signs (and 1 which is potentially serious) we think you should know about.

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.