Yahoo Finance Is Hera (BIT:HER) Using Too Much Debt?
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.' 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 can see that Hera S.p.A. (BIT:HER) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for Hera
What Is Hera's Debt?
As you can see below, at the end of March 2019, Hera had €3.53b of debt, up from €3.22b a year ago. Click the image for more detail. On the flip side, it has €712.5m in cash leading to net debt of about €2.82b.
A Look At Hera's Liabilities
Zooming in on the latest balance sheet data, we can see that Hera had liabilities of €3.17b due within 12 months and liabilities of €3.57b due beyond that. On the other hand, it had cash of €712.5m and €2.24b worth of receivables due within a year. So it has liabilities totalling €3.79b more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of €5.03b, so it does suggest shareholders should keep an eye on Hera's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Hera has a debt to EBITDA ratio of 3.1 and its EBIT covered its interest expense 6.8 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. We saw Hera grow its EBIT by 5.1% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Hera's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
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, Hera recorded free cash flow of 46% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Our View
Both Hera's level of total liabilities and its net debt to EBITDA were discouraging. But its not so bad at covering its interest expense with its EBIT. It's also worth noting that Hera is in the Integrated Utilities industry, which is often considered to be quite defensive. Looking at all the angles mentioned above, it does seem to us that Hera is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. Over time, share prices tend to follow earnings per share, so if you're interested in Hera, you may well want to click here to check an interactive graph of its earnings per share history.
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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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.
