Warren Buffett famously said, ‘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. We note that Inter Cars S.A. (WSE:CAR) does have debt on its balance sheet. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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. 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. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for Inter Cars
How Much Debt Does Inter Cars Carry?
As you can see below, at the end of September 2024, Inter Cars had zł2.45b of debt, up from zł2.19b a year ago. Click the image for more detail. However, because it has a cash reserve of zł430.6m, its net debt is less, at about zł2.02b.
A Look At Inter Cars’ Liabilities
Zooming in on the latest balance sheet data, we can see that Inter Cars had liabilities of zł3.79b due within 12 months and liabilities of zł1.87b due beyond that. Offsetting this, it had zł430.6m in cash and zł2.99b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by zł2.23b.
While this might seem like a lot, it is not so bad since Inter Cars has a market capitalization of zł8.26b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it’s clear that we should definitely closely examine whether it can manage its debt without dilution.
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Inter Cars’s net debt is sitting at a very reasonable 1.8 times its EBITDA, while its EBIT covered its interest expense just 6.8 times last year. While that doesn’t worry us too much, it does suggest the interest payments are somewhat of a burden. The bad news is that Inter Cars saw its EBIT decline by 17% over the last year. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. 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 Inter Cars 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Considering the last three years, Inter Cars actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
Our View
To be frank both Inter Cars’s conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least it’s pretty decent at covering its interest expense with its EBIT; that’s encouraging. Once we consider all the factors above, together, it seems to us that Inter Cars’s debt is making it a bit risky. Some people like that sort of risk, but we’re mindful of the potential pitfalls, so we’d probably prefer it carry less debt. There’s no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet – far from it. Be aware that Inter Cars is showing 1 warning sign in our investment analysis , you should know about…
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
