Howard Marks put it well when he said that, rather than worrying about stock price volatility, “The possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried. ” So it can be obvious that you need to consider debt, when you think about how risky a given stock is, because too much debt can sink a business. We notice that Schibsted ASA (OB: SCHA) has a debt on its balance sheet. But does this debt worry shareholders?
What risk does debt entail?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. Of course, debt can be an important tool in businesses, especially capital intensive businesses. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
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What is Schibsted’s net debt?
The image below, which you can click for more details, shows that Schibsted had debt of Kroner 6.42 billion at the end of June 2021, a reduction from Kroner 8.43 billion year on year. . However, because it has a cash reserve of Kroner 727.0 million, its net debt is less, at around Kroner 5.70 billion.
A look at the responsibilities of Schibsted
The latest balance sheet data shows that Schibsted had debt of Kroner 3.69 billion due within one year, and KKr 9.83 billion debt due thereafter. In compensation for these obligations, he had cash of Kroner 727.0 million as well as claims valued at Kroner 1.88 billion within 12 months. Its liabilities therefore total SEK 10.9 billion more than the combination of its cash and short-term receivables.
Considering that Schibsted has a whopping market cap of 102.1 billion crowns, it’s hard to believe that these liabilities pose a significant threat. But there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). Thus, we consider debt versus earnings with and without amortization charges.
Schibsted has a debt to EBITDA ratio of 3.4, which signals significant debt, but is still fairly reasonable for most types of businesses. However, its interest coverage of 11.8 is very high, suggesting that interest charges on debt are currently quite low. Importantly, Schibsted has increased its EBIT by 83% over the past twelve months, and this growth will make it easier to process its debt. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Schibsted can strengthen its balance sheet over time. So if you are focused on the future you can check out this free report showing analysts‘ earnings forecasts.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, Schibsted has generated free cash flow of 97% of its EBIT, more than we expected. This puts him in a very strong position to pay off the debt.
Our point of view
Schibsted’s conversion of EBIT to free cash flow suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. But frankly, we think its net debt to EBITDA undermines that impression a bit. Zooming out, Schibsted seems to be using the debt in a very reasonable way; and that gets the nod from us. While debt comes with risk, when used wisely, it can also generate a higher return on equity. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we have identified 1 warning sign for Schibsted that you need to be aware of.
At the end of the day, it’s often best to focus on businesses with no net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
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