Warren Buffett said: “Volatility is far from synonymous with risk”. 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. Above all, Snam SpA (BIT: SRG) is in debt. But the most important question is: what risk does this debt create?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
Check out our latest analysis for Snam
How much debt does Snam have?
The graph below, which you can click for more details, shows that Snam had € 15.7 billion in debt as of September 2021; about the same as the year before. However, he also had € 1.92 billion in cash, so his net debt is € 13.8 billion.
How strong is Snam’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Snam had a liability of 5.76 billion euros due within 12 months and a liability of 10.2 billion euros due beyond. In return, he had € 1.92 billion in cash and € 2.01 billion in receivables due within 12 months. Its liabilities therefore amount to € 12.0 billion more than the combination of its cash and short-term receivables.
That’s a mountain of leverage even compared to its gargantuan market capitalization of € 16.4 billion. This suggests that shareholders would be heavily diluted if the company needed to consolidate its balance sheet quickly.
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). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
Strangely, Snam has a very high EBITDA ratio of 6.2, which implies high debt, but strong interest coverage of 18.2. So either he has access to very cheap long-term debt or his interest charges will go up! It is important to note that Snam’s EBIT has been essentially stable over the past twelve months. We would rather see some growth in earnings as it always helps reduce debt. There is no doubt that we learn the most about debt from the balance sheet. But it is future profits, more than anything, that will determine Snam’s ability to maintain a healthy balance sheet in the future. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. 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, Snam’s free cash flow has been 30% of its EBIT, less than we expected. It’s not great when it comes to paying down debt.
Our point of view
Snam’s net indebtedness to EBITDA and the level of total liabilities certainly weigh on this, in our opinion. But her coverage of interest tells a very different story and suggests some resilience. It should also be noted that Snam is in the gas utilities industry, which is often viewed as quite defensive. Taking the above factors together, we believe that Snam’s debt presents certain risks to the business. While this debt may increase returns, we believe the company now has sufficient leverage. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. To this end, you should inquire about the 3 warning signs we spotted with Snam (including 2 that are of concern).
If you are interested in investing in companies that can generate profits without the burden of debt, check out this page free list of growing companies that have net cash on the balance sheet.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in any of the stocks mentioned.
Do you have any feedback on this item? Are you worried about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.
Comments are closed.