Does Bras (WSE:BSA) use too much debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Like many other companies Arm SA (WSE:BSA) uses debt. But the real question is whether this debt makes the business risky.

When is debt dangerous?

Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.

See our latest review for Arms

What is Bras’s net debt?

As you can see below, Bras had a debt of 8.34 million zł in December 2021, compared to 8.96 million zł the previous year. However, he has 181.4 kzł in cash to offset this, resulting in a net debt of approximately 8.16 million zł.

WSE: BSA debt-to-equity history May 9, 2022

How healthy is Bras’s balance sheet?

We can see from the most recent balance sheet that Bras had liabilities of 5.83 million zł due in one year, and liabilities of 8.28 million zł due beyond. As compensation for these obligations, it had cash of 181.4 kzł as well as receivables valued at 2.76 million zł, payable within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of zł 11.2 million.

This shortfall is not that bad as Bras is worth 22.2 million zł and therefore could probably raise enough capital to shore up its balance sheet, should the need arise. However, it is always worth taking a close look at its ability to repay debt.

We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

Bras has a fairly high debt-to-EBITDA ratio of 7.7, which suggests significant leverage. However, its interest coverage of 3.2 is reasonably strong, which is a good sign. On the bright side, Bras grew its EBIT by a silky 58% last year. Like the milk of human kindness, this type of growth increases resilience, making the business more capable of managing debt. There is no doubt that we learn the most about debt from the balance sheet. But it’s Bras’ earnings that will influence the balance sheet going forward. So, if you want to know more about its earnings, it may be worth checking out this graph of its long-term trend.

But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Bras has generated free cash flow of a very strong 89% of its EBIT, more than we expected. This puts him in a very strong position to repay his debt.

Our point of view

Based on what we’ve seen, Bras doesn’t find it easy, given its net debt to EBITDA ratio, but the other factors we’ve considered give us cause for optimism. There’s no doubt that its ability to convert EBIT to free cash flow is pretty dazzling. When considering all of the items mentioned above, it seems to us that Bras is managing its debt quite well. That said, the charge is heavy enough that we recommend that any shareholder keep a close eye on it. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Example: we have identified 3 warning signs for Bras you should be aware, and 2 of them are a bit of a concern.

In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeright now.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.


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John A. Bogar