Is Sphera Franchise Group (BVB:SFG) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Sphera Franchise Group S.A. (BVB:SFG) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Sphera Franchise Group

What Is Sphera Franchise Group's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Sphera Franchise Group had debt of RON146.7m, up from RON119.6m in one year. However, it also had RON113.3m in cash, and so its net debt is RON33.3m.

How Healthy Is Sphera Franchise Group's Balance Sheet?

According to the last reported balance sheet, Sphera Franchise Group had liabilities of RON217.4m due within 12 months, and liabilities of RON289.8m due beyond 12 months. On the other hand, it had cash of RON113.3m and RON19.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by RON374.4m.

This is a mountain of leverage relative to its market capitalization of RON578.1m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). 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).

Sphera Franchise Group has a very low debt to EBITDA ratio of 0.55 so it is strange to see weak interest coverage, with last year's EBIT being only 1.9 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. Shareholders should be aware that Sphera Franchise Group's EBIT was down 57% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Sphera Franchise Group'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, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Sphera Franchise Group produced sturdy free cash flow equating to 63% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

On the face of it, Sphera Franchise Group's interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at managing its debt, based on its EBITDA,; that's encouraging. Once we consider all the factors above, together, it seems to us that Sphera Franchise Group'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. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Like risks, for instance. Every company has them, and we've spotted 3 warning signs for Sphera Franchise Group (of which 1 can't be ignored!) 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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