BEST (WSE:BST) Takes On Some Risk With Its Use Of Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 note that BEST S.A. (WSE:BST) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for BEST

What Is BEST's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 BEST had zł557.8m of debt, an increase on zł386.0m, over one year. However, because it has a cash reserve of zł55.9m, its net debt is less, at about zł501.9m.

How Healthy Is BEST's Balance Sheet?

The latest balance sheet data shows that BEST had liabilities of zł53.8m due within a year, and liabilities of zł600.3m falling due after that. Offsetting these obligations, it had cash of zł55.9m as well as receivables valued at zł60.7m due within 12 months. So it has liabilities totalling zł537.5m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of zł544.6m, so it does suggest shareholders should keep an eye on BEST's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

BEST has a debt to EBITDA ratio of 3.3 and its EBIT covered its interest expense 4.7 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Importantly, BEST's EBIT fell a jaw-dropping 33% 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 it is BEST'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, BEST recorded free cash flow of 36% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

We'd go so far as to say BEST's EBIT growth rate was disappointing. Having said that, its ability to cover its interest expense with its EBIT isn't such a worry. Overall, it seems to us that BEST's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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, we've discovered 2 warning signs for BEST (1 can't be ignored!) that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.