The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, GROUPE SFPI SA (EPA:SFPI) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is GROUPE SFPI's Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2018 GROUPE SFPI had €99.2m of debt, an increase on €68.6m, over one year. But on the other hand it also has €127.9m in cash, leading to a €28.7m net cash position.
A Look At GROUPE SFPI's Liabilities
According to the last reported balance sheet, GROUPE SFPI had liabilities of €177.2m due within 12 months, and liabilities of €140.2m due beyond 12 months. Offsetting this, it had €127.9m in cash and €134.7m in receivables that were due within 12 months. So it has liabilities totalling €54.7m more than its cash and near-term receivables, combined.
This deficit isn't so bad because GROUPE SFPI is worth €186.7m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, GROUPE SFPI boasts net cash, so it's fair to say it does not have a heavy debt load!
On the other hand, GROUPE SFPI saw its EBIT drop by 7.0% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. 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 GROUPE SFPI's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While GROUPE SFPI has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, GROUPE SFPI recorded free cash flow worth 50% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Although GROUPE SFPI's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €29m. So we don't have any problem with GROUPE SFPI's use of debt. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of GROUPE SFPI's earnings per share history for free.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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