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Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Ibersol, S.G.P.S., S.A. (ELI:IBS) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Ibersol S.G.P.S’s Net Debt?
As you can see below, Ibersol S.G.P.S had €134.4m of debt, at March 2019, which is about the same the year before. You can click the chart for greater detail. On the flip side, it has €37.3m in cash leading to net debt of about €97.1m.
How Healthy Is Ibersol S.G.P.S’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Ibersol S.G.P.S had liabilities of €174.9m due within 12 months and liabilities of €382.4m due beyond that. Offsetting these obligations, it had cash of €37.3m as well as receivables valued at €26.0m due within 12 months. So its liabilities total €494.0m more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the €261.1m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Ibersol S.G.P.S would likely require a major re-capitalisation if it had to pay its creditors today. Since Ibersol S.G.P.S does have net debt, we think it is worthwhile for shareholders to keep an eye on the balance sheet, over time.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
While Ibersol S.G.P.S’s low debt to EBITDA ratio of 1.41 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 4.78 last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. The bad news is that Ibersol S.G.P.S saw its EBIT decline by 16% over the last year. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. 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 Ibersol S.G.P.S’s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Ibersol S.G.P.S produced sturdy free cash flow equating to 66% of its EBIT, about what we’d expect. This cold hard cash means it can reduce its debt when it wants to.
On the face of it, Ibersol S.G.P.S’s EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it’s pretty decent at converting EBIT to free cash flow; that’s encouraging. Overall, it seems to us that Ibersol S.G.P.S’s debt load is really quite a risk to the business. So we’re almost as wary of this stock as a hungry kitten is about falling into its owner’s fish pond: once bitten, twice shy, as they say. Over time, share prices tend to follow earnings per share, so if you’re interested in Ibersol S.G.P.S, you may well want to click here to check an interactive graph of its earnings per share history.
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.
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If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.