Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We note that AmRest Holdings SE (WSE:EAT) has debt on its balance sheet. But the more important question is: what risk does this debt create?
When is debt dangerous?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we think about a company’s use of debt, we first look at cash and debt together.
Check out our latest analysis for AmRest Holdings
What is AmRest Holdings’ net debt?
As you can see below, AmRest Holdings had 664.6 million euros in debt in December 2021, compared to 770.8 million euros the previous year. On the other hand, he has €198.7 million in cash, resulting in a net debt of around €465.9 million.
How healthy is AmRest Holdings’ balance sheet?
The latest balance sheet data shows that AmRest Holdings had liabilities of 579.3 million euros due within one year, and liabilities of 1.29 billion euros falling due thereafter. In return, it had 198.7 million euros in cash and 72.8 million euros in receivables due within 12 months. It therefore has liabilities totaling 1.60 billion euros more than its cash and short-term receivables, combined.
The deficiency here weighs heavily on the company itself of 947.8 million euros, like a child struggling under the weight of a huge backpack full of books, his sports equipment and a trumpet. We would therefore be watching his balance sheet closely, no doubt. After all, AmRest Holdings would likely need a major recapitalization if it were to pay its creditors today.
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.
While AmRest Holdings’ debt to EBITDA ratio (2.8) suggests it is using some debt, its interest coverage is very low at 1.7, suggesting high leverage. It appears that the company is incurring significant depreciation and amortization costs, so perhaps its debt load is heavier than it appears at first glance, since EBITDA is undoubtedly a generous measure benefits. It seems clear that the cost of borrowing money is having a negative impact on shareholder returns lately. However, the silver lining was that AmRest Holdings achieved a positive EBIT of €64 million in the last twelve months, an improvement on the loss of the previous year. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine AmRest Holdings’ ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, a company can only repay its debts with cold hard cash, not with book profits. It is therefore worth checking how much of earnings before interest and tax (EBIT) is supported by free cash flow. Over the past year, AmRest Holdings has actually produced more free cash flow than EBIT. There’s nothing better than incoming money to stay in the good books of your lenders.
Our point of view
To be frank, AmRest Holdings’ interest coverage and track record of keeping its total liabilities under control makes us rather uncomfortable with its level of leverage. But at least it’s decent enough to convert EBIT to free cash flow; it’s encouraging. Looking at the big picture, it seems clear to us that AmRest Holdings’ use of debt creates risks for the business. If all goes well, it can pay off, but the downside of this debt is a greater risk of permanent losses. 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 outside of the balance sheet. For example, AmRest Holdings has 3 warning signs (and 1 which is potentially serious) that we think you should know about.
If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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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.