Some say that volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett once said that “volatility is far from synonymous with risk.” It seems the smart money knows that debt – which usually comes with bankruptcies – is a very important factor when you assess how risky a company is. We can see that Rand hf. (ICE:BRIM) does use debt in its business. But should shareholders be concerned about using debt?
When is debt a problem?
In general, debt only becomes a real problem if a company cannot easily pay it off, either by raising capital or using its own cash flow. An essential part of capitalism is the process of ‘creative destruction’, in which failed companies are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it needs to raise new equity at a low price, permanently diluting shareholders. However, by replacing dilution, debt can be an extremely good tool for companies that need capital to invest in high-yield growth. When we think about a company’s use of debt, let’s first look at cash and debt together.
How much debt does Brim hf bear?
The image below, which you can click on for more details, shows that Brim hf had debt of €318.9 million in December 2020, an increase of €273.8 million in one year. On the other hand, it has €21.6 million in cash, leading to a net debt of approximately €297.3 million.
A look at Brim hf’s obligations
According to the last reported balance sheet, Brim hf had liabilities of €101.7 million with a maturity of more than 12 months, and liabilities of €325.9 million with a maturity of more than 12 months. Against these liabilities, it had €21.6 million in cash, as well as €37.9 million receivables to be paid within 12 months. It thus has debts totaling €368.0 million more than its cash and short-term receivables combined.
Brim hf has a market cap of €744.4 million, so it could very likely raise funds to improve its balance sheet, should the need arise. But it’s clear that we definitely need to scrutinize whether it can manage its debt without dilution.
We measure a company’s indebtedness relative to its earning capital by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and by calculating how easily its earnings before interest and taxes (EBIT) offset interest. cover costs (interest cover). In this way, we take into account both the absolute amount of the debt and the interest rates paid on it.
Brim hf’s net debt to EBITDA ratio is 5.2 indicating a fairly high level of debt, but the 7.5 times interest cover suggests that the debt can be easily repaid. Overall, we’d say it seems likely that the company has a fairly heavy amount of debt. The bad news is that Brim hf saw its EBIT fall by 13% last year. If revenues continue to fall at that rate, it will be harder to deal with debt than going to a fancy trouser restaurant with three kids under five. The balance sheet is clearly the area to focus on when analyzing debt. But it is Brim hf’s income that will affect its balance sheet going forward. So when considering debt, it’s definitely worth looking at earnings performance. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we need to see clearly whether that EBIT leads to a corresponding free cash flow. Looking at the most recent three years, Brim hf posted free cash flow of 50% of its EBIT, which is weaker than we expected. That weak cash conversion makes it harder to deal with debt.
To be fair, both Brim hf’s EBIT growth and track record of managing its debt, based on its EBITDA, make us quite uncomfortable with its debt levels. But on the upside, the interest rate cover is a good sign and makes us more optimistic. If we consider all the above factors together, it seems to us that the debt of Brim hf makes it a bit risky. That’s not necessarily a bad thing, but we’d feel more comfortable with less leverage overall. The balance sheet is clearly the area to focus on when analyzing debt. But in the end, any business can contain risks that exist off-balance sheet. To do this, you need to learn more about the 3 warning signs we spotted Brim hf (including 2 that can’t be ignored) .
When all is said and done, sometimes it’s easier to focus on businesses that don’t even need debt. Readers have access to a list of growth stocks with no net debt 100% free, straight away.
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