Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say this when he says “The biggest risk in investing is not price volatility, but if you will suffer a loss. permanent capital “. So it can be obvious that you need to consider debt, when you think about how risky a given stock is, because too much debt can sink a business. We notice that Plaza SA (SNSE: MALLPLAZA) has debt on its balance sheet. But does this debt worry shareholders?
What risk does debt entail?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. If things really go wrong, lenders can take over the business. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
See our latest analysis for Plaza
What is Plaza’s debt?
The image below, which you can click for more details, shows that Plaza had a debt of 1.05 CL ton at the end of September 2021, a reduction from 1.24 CL ton year on year. On the other hand, it has CL $ 118.6 billion in cash, resulting in net debt of around CL $ 927.1 billion.
How strong is Plaza’s balance sheet?
According to the latest published balance sheet, Plaza had debts of CL $ 169.3 billion due within 12 months and liabilities of CL $ 1.44 tons beyond 12 months. In return, he had CL $ 118.6 billion in cash and CL $ 99.1 billion in receivables due within 12 months. Its liabilities are therefore 1.40 tonnes of CL $ more than the combination of its cash and short-term receivables.
This is a mountain of leverage compared to its market cap of CL $ 1.69 t. This suggests that shareholders would be greatly diluted if the company needed to consolidate its balance sheet quickly.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
With a net debt to EBITDA ratio of 5.2, it’s fair to say that Plaza has significant debt. But the good news is that he enjoys a pretty heartwarming 3.8 times interest coverage, which suggests he can meet his obligations responsibly. Looking on the bright side, Plaza has grown its EBIT silky 92% over the past year. Like the milk of human kindness, this type of growth increases resilience, making the business more capable of handling debt. There is no doubt that we learn the most about debt from the balance sheet. But it is future profits, more than anything, that will determine Plaza’s ability to maintain a healthy balance sheet going forward. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. In the past three years, Plaza has generated more free cash flow than EBIT. This kind of solid silver generation warms our hearts like a puppy in a bumblebee costume.
Our point of view
The conversion of Plaza’s EBIT into free cash flow was a real asset in this analysis, as was its rate of growth in EBIT. On the other hand, our confidence was undermined by its apparent difficulty in managing its debt, on the basis of its EBITDA. Given this range of data points, we believe Plaza is well positioned to manage its debt levels. But beware: we believe debt levels are high enough to warrant continued monitoring. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. We have identified 1 warning sign with Plaza and understanding them should be part of your investment process.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.