Warren Buffett said: “Volatility is far from synonymous with risk. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We note that Seven Group Holdings Limited (ASX:SVW) has debt on its balance sheet. But does this debt worry shareholders?
When is debt dangerous?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. If things go really bad, lenders can take over the business. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
See our latest analysis for Seven Group Holdings
How much debt does Seven Group Holdings have?
As you can see below, at the end of December 2021, Seven Group Holdings had A$7.95 billion in debt, up from A$2.86 billion a year ago. Click on the image for more details. However, since it has a cash reserve of A$3.77 billion, its net debt is less, at around A$4.18 billion.
A look at the liabilities of Seven Group Holdings
According to the latest published balance sheet, Seven Group Holdings had liabilities of A$5.44 billion due within 12 months and liabilities of A$6.16 billion due beyond 12 months. On the other hand, it had A$3.77 billion in cash and A$1.34 billion in receivables due within a year. It therefore has liabilities totaling A$6.49 billion more than its cash and short-term receivables, combined.
This is a mountain of leverage compared to its market capitalization of A$8.19 billion. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Seven Group Holdings’ net debt of 2.1x EBITDA suggests judicious use of debt. And the attractive interest coverage (EBIT of 8.4 times interest expense) certainly makes do not do everything to dispel this impression. Fortunately, Seven Group Holdings is growing its EBIT faster than former Australian Prime Minister Bob Hawke dropped a yard glass, with a 140% gain over the last twelve months. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Seven Group Holdings can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, while the taxman may love accounting profits, lenders only accept cash. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Seven Group Holdings has recorded free cash flow of 24% of its EBIT, which is lower than expected. It’s not great when it comes to paying off debt.
Our point of view
On the balance sheet, the most notable positive for Seven Group Holdings is the fact that it looks capable of growing its EBIT with confidence. But the other factors we noted above weren’t so encouraging. For example, it looks like he has to struggle a bit to manage his total liabilities. When we consider all of the factors mentioned above, we feel a bit cautious about Seven Group Holdings’ use of debt. While we understand that debt can improve returns on equity, we suggest shareholders keep a close eye on their level of debt, lest it increase. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, Seven Group Holdings has 3 warning signs (and 2 that make us uncomfortable) that we think you should know about.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.