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.' 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. We note that Jerónimo Martins, SGPS, S.A. (ELI:JMT) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.
What Is Jerónimo Martins SGPS's Debt?
The image below, which you can click on for greater detail, shows that at March 2019 Jerónimo Martins SGPS had debt of €3.11b, up from €690.1m in one year. However, it also had €627.9m in cash, and so its net debt is €2.48b.
A Look At Jerónimo Martins SGPS's Liabilities
The latest balance sheet data shows that Jerónimo Martins SGPS had liabilities of €4.60b due within a year, and liabilities of €2.40b falling due after that. Offsetting this, it had €627.9m in cash and €377.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €5.99b.
This deficit is considerable relative to its very significant market capitalization of €9.27b, so it does suggest shareholders should keep an eye on Jerónimo Martins SGPS's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Jerónimo Martins SGPS has a debt to EBITDA ratio of 2.5, which betrays significant debt, but is still pretty reasonable for most types of business. But its EBIT was about 11.3 times its interest expense, implying the company isn't really paying full freight on that debt. Even if not sustainable, that is a good sign. Importantly Jerónimo Martins SGPS's EBIT was essentially flat over the last twelve months. We would prefer to see some earnings growth, because that always helps diminish debt. 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 Jerónimo Martins SGPS'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 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, Jerónimo Martins SGPS's free cash flow amounted to 49% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Neither Jerónimo Martins SGPS's ability to handle its total liabilities nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. Looking at all the angles mentioned above, it does seem to us that Jerónimo Martins SGPS is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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 Jerónimo Martins SGPS's earnings per share history for free.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.