Does Flour Mills C. Sarantopoulos (ATH:KYSA) Have A Healthy Balance Sheet?
Simply Wall St
Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about. It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Flour Mills C. Sarantopoulos S.A. (ATH:KYSA) does use debt in its business. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
As you can see below, Flour Mills C. Sarantopoulos had €10.7m of debt, at December 2018, which is about the same the year before. You can click the chart for greater detail. However, because it has a cash reserve of €387.0k, its net debt is less, at about €10.4m.
ATSE:KYSA Historical Debt, September 27th 2019
A Look At Flour Mills C. Sarantopoulos's Liabilities
The latest balance sheet data shows that Flour Mills C. Sarantopoulos had liabilities of €15.6m due within a year, and liabilities of €4.63m falling due after that. Offsetting this, it had €387.0k in cash and €6.38m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €13.5m.
This deficit is considerable relative to its market capitalization of €13.8m, so it does suggest shareholders should keep an eye on Flour Mills C. Sarantopoulos's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Flour Mills C. Sarantopoulos shareholders face the double whammy of a high net debt to EBITDA ratio (9.8), and fairly weak interest coverage, since EBIT is just 0.91 times the interest expense. The debt burden here is substantial. However, one redeeming factor is that Flour Mills C. Sarantopoulos grew its EBIT at 11% over the last 12 months, boosting its ability to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Flour Mills C. Sarantopoulos's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Flour Mills C. Sarantopoulos recorded free cash flow of 38% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Our View
To be frank both Flour Mills C. Sarantopoulos's net debt to EBITDA and its track record of covering its interest expense with its EBIT make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Looking at the bigger picture, it seems clear to us that Flour Mills C. Sarantopoulos's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. While Flour Mills C. Sarantopoulos didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away.Click here to see if its earnings are heading in the right direction, over the medium term.
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If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
