Flour Mills Kepenos (ATH:KEPEN) Has A Somewhat Strained 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. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Flour Mills Kepenos S.A. (ATH:KEPEN) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, 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 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 Kepenos had €15.1m of debt, at December 2018, which is about the same the year before. You can click the chart for greater detail. However, it does have €964.8k in cash offsetting this, leading to net debt of about €14.1m.
ATSE:KEPEN Historical Debt, September 24th 2019
How Strong Is Flour Mills Kepenos's Balance Sheet?
According to the last reported balance sheet, Flour Mills Kepenos had liabilities of €3.88m due within 12 months, and liabilities of €17.0m due beyond 12 months. Offsetting these obligations, it had cash of €964.8k as well as receivables valued at €14.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €5.67m.
While this might seem like a lot, it is not so bad since Flour Mills Kepenos has a market capitalization of €10.4m, 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.
Flour Mills Kepenos shareholders face the double whammy of a high net debt to EBITDA ratio (7.1), and fairly weak interest coverage, since EBIT is just 2.3 times the interest expense. This means we'd consider it to have a heavy debt load. Looking on the bright side, Flour Mills Kepenos boosted its EBIT by a silky 31% in the last year. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Flour Mills Kepenos will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Flour Mills Kepenos burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Our View
On the face of it, Flour Mills Kepenos's net debt to EBITDA left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Flour Mills Kepenos stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. Over time, share prices tend to follow earnings per share, so if you're interested in Flour Mills Kepenos, you may well want to click here to check an interactive graph of its earnings per share history.
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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.
