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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, EBOS Group Limited (NZSE:EBO) does carry debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for EBOS Group
How Much Debt Does EBOS Group Carry?
As you can see below, EBOS Group had AU$543.0m of debt at June 2019, down from AU$584.3m a year prior. However, it does have AU$166.6m in cash offsetting this, leading to net debt of about AU$376.4m.
How Strong Is EBOS Group's Balance Sheet?
The latest balance sheet data shows that EBOS Group had liabilities of AU$1.52b due within a year, and liabilities of AU$441.9m falling due after that. Offsetting this, it had AU$166.6m in cash and AU$897.9m in receivables that were due within 12 months. So it has liabilities totalling AU$898.5m more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since EBOS Group has a market capitalization of AU$3.62b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
EBOS Group has net debt of just 1.5 times EBITDA, indicating that it is certainly not a reckless borrower. And this view is supported by the solid interest coverage, with EBIT coming in at 8.9 times the interest expense over the last year. We saw EBOS Group grow its EBIT by 5.3% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if EBOS Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.