Howard Marks said 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 that every practical investor that I know is worried”. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We note that Best Collective A/S (STO:BETCO) has debt on its balance sheet. But does this debt worry shareholders?
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, 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 it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for Better Collective
What is Better Collective’s debt?
You can click on the graph below for historical figures, but it shows that in December 2021, Better Collective had €136.6 million in debt, an increase from €87.9 million, on a year. However, he also had €28.6 million in cash, so his net debt is €108.0 million.
A look at the responsibilities of Better Collective
The latest balance sheet data shows that Better Collective had liabilities of €55.5 million due within the year, and liabilities of €197.1 million due thereafter. In return, it had €28.6 million in cash and €30.6 million in receivables due within 12 months. Its liabilities therefore total €193.3 million more than the combination of its cash and short-term receivables.
While that might sound like a lot, it’s not too bad since Better Collective has a market capitalization of €892.6 million, so it could probably bolster its balance sheet by raising capital if needed. But we definitely want to keep our eyes peeled for indications that its debt is too risky.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
We would say that Better Collective’s moderate net debt to EBITDA ratio (2.0) indicates prudence in terms of leverage. And its strong interest coverage of 21.5 times makes us even more comfortable. It should be noted that Better Collective’s EBIT has jumped like bamboo after rain, gaining 55% over the last twelve months. This will make it easier to manage your debt. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Better Collective can strengthen its balance sheet over time. 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 its debts; book profits are not enough. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Better Collective has recorded free cash flow of 40% of its EBIT, which is lower than expected. It’s not great when it comes to paying off debt.
Our point of view
Fortunately, Better Collective’s impressive interest coverage means it has the upper hand on its debt. And this is only the beginning of good news since its EBIT growth rate is also very encouraging. When we consider the range of factors above, it seems that Better Collective is quite sensitive with its use of debt. This means they take on a bit more risk, hoping to increase shareholder returns. 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. Example: we have identified 3 warning signs for Better Collective you should be aware.
If you are interested in investing in businesses 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.