These 4 Measures Indicate That Spectrum Brands Holdings (NYSE:SPB) Is Using Debt Extensively

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.' 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 Spectrum Brands Holdings, Inc. (NYSE:SPB) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. 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.

View our latest analysis for Spectrum Brands Holdings

What Is Spectrum Brands Holdings's Debt?

The image below, which you can click on for greater detail, shows that Spectrum Brands Holdings had debt of US$2.41b at the end of April 2021, a reduction from US$2.85b over a year. However, because it has a cash reserve of US$290.0m, its net debt is less, at about US$2.12b.

How Healthy Is Spectrum Brands Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Spectrum Brands Holdings had liabilities of US$926.4m due within 12 months and liabilities of US$2.85b due beyond that. Offsetting these obligations, it had cash of US$290.0m as well as receivables valued at US$608.0m due within 12 months. So it has liabilities totalling US$2.88b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of US$3.76b, so it does suggest shareholders should keep an eye on Spectrum Brands Holdings' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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).

Spectrum Brands Holdings has a debt to EBITDA ratio of 3.2 and its EBIT covered its interest expense 3.1 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. The good news is that Spectrum Brands Holdings grew its EBIT a smooth 57% over the last twelve months. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. 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 Spectrum Brands Holdings'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 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. In the last three years, Spectrum Brands Holdings's free cash flow amounted to 46% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Neither Spectrum Brands Holdings's ability to cover its interest expense with its EBIT nor its level of total liabilities gave us confidence in its ability to take on more debt. But its EBIT growth rate tells a very different story, and suggests some resilience. Looking at all the angles mentioned above, it does seem to us that Spectrum Brands Holdings is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Spectrum Brands Holdings you should be aware of, and 1 of them can't be ignored.

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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