Eurosnack (WSE:ECK) Could Easily Take On More Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Eurosnack S.A. (WSE:ECK) does use debt in its business. But should shareholders be worried about its use of debt?

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 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Eurosnack

How Much Debt Does Eurosnack Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2023 Eurosnack had zł6.73m of debt, an increase on zł5.32m, over one year. However, it does have zł1.66m in cash offsetting this, leading to net debt of about zł5.07m.

A Look At Eurosnack's Liabilities

According to the last reported balance sheet, Eurosnack had liabilities of zł26.6m due within 12 months, and liabilities of zł3.45m due beyond 12 months. Offsetting this, it had zł1.66m in cash and zł13.2m in receivables that were due within 12 months. So it has liabilities totalling zł15.2m more than its cash and near-term receivables, combined.

Given Eurosnack has a market capitalization of zł82.4m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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.

While Eurosnack's low debt to EBITDA ratio of 0.47 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 4.8 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Notably, Eurosnack's EBIT launched higher than Elon Musk, gaining a whopping 117% on last year. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Eurosnack will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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. Happily for any shareholders, Eurosnack actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

The good news is that Eurosnack's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its EBIT growth rate also supports that impression! Zooming out, Eurosnack seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Eurosnack is showing 3 warning signs in our investment analysis , you should know about...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.