Is Empresaria Group (LON:EMR) Using Too Much Debt?
Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Empresaria Group plc (LON:EMR) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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 think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for Empresaria Group
How Much Debt Does Empresaria Group Carry?
The chart below, which you can click on for greater detail, shows that Empresaria Group had UK£38.1m in debt in June 2019; about the same as the year before. However, because it has a cash reserve of UK£21.2m, its net debt is less, at about UK£16.9m.
A Look At Empresaria Group's Liabilities
Zooming in on the latest balance sheet data, we can see that Empresaria Group had liabilities of UK£75.5m due within 12 months and liabilities of UK£20.6m due beyond that. On the other hand, it had cash of UK£21.2m and UK£56.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£18.8m.
This is a mountain of leverage relative to its market capitalization of UK£30.5m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
With net debt sitting at just 1.1 times EBITDA, Empresaria Group is arguably pretty conservatively geared. And it boasts interest cover of 8.3 times, which is more than adequate. Empresaria Group's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Empresaria Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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, Empresaria Group's free cash flow amounted to 41% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Our View
Even if we have reservations about how easily Empresaria Group is capable of staying on top of its total liabilities, its interest cover and net debt to EBITDA make us think feel relatively unconcerned. We think that Empresaria Group's debt does make it a bit risky, after considering the aforementioned data points together. 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. Given Empresaria Group has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.
