Is Seven West Media (ASX: SWM) a risky investment?

Warren Buffett said: “Volatility is far from synonymous with risk”. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Like many other companies Seven West Media Limited (ASX: SWM) 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 repay it, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still painful) scenario is that he must raise new equity at low cost, thereby diluting shareholders over the long term. Of course, debt can be an important tool in businesses, especially capital intensive businesses. The first step in examining a company’s debt levels is to consider its cash flow and debt together.

Check out our latest analysis for Seven West Media

What is Seven West Media’s net debt?

You can click on the graph below for historical figures, but it shows that Seven West Media had A $ 495.2 million in debt as of June 2021, up from A $ 757.1 million a year earlier. However, he also had A $ 253.3 million in cash, so his net debt is A $ 241.9 million.

ASX: SWM History of debt to equity November 2, 2021

Is Seven West Media’s track record healthy?

According to the latest published balance sheet, Seven West Media had a liability of A $ 516.6 million due within 12 months and a liability of A $ 922.7 million due beyond 12 months. On the other hand, he had A $ 253.3 million in cash and A $ 214.4 million in receivables due within one year. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by A $ 971.5 million.

Given that this deficit is actually greater than the company’s market cap of A $ 821.0 million, we believe shareholders should really watch Seven West Media’s debt levels, like a parent watching their child riding a bicycle for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely that shareholders would suffer a significant dilution.

In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).

While Seven West Media’s low debt-to-EBITDA ratio of 0.82 suggests only a modest use of debt, the fact that EBIT only covered interest expense 4.7 times over the past year makes think. But the interest payments are certainly enough to make us think about how affordable his debt is. Notably, Seven West Media recorded a loss in EBIT level last year, but improved it to a positive EBIT of A $ 282 million in the past twelve months. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Seven West Media can strengthen its balance sheet over time. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. It is therefore important to check how much of its earnings before interest and taxes (EBIT) converts into actual free cash flow. Seven West Media’s free cash flow last year was 45% of its EBIT, less than we expected. This low cash conversion makes debt management more difficult.

Our point of view

Reflecting on Seven West Media’s attempt to stay on top of its total liabilities, we are certainly not enthusiastic. But on the positive side, its net debt to EBITDA is a good sign and makes us more optimistic. Looking at the balance sheet and taking all of these factors into account, we think debt makes Seven West Media stock a bit risky. Some people like this kind of risk, but we are aware of the potential pitfalls, so we would probably prefer him to carry less debt. 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 off the balance sheet. For example, Seven West Media has 4 warning signs (and 2 that shouldn’t be ignored) we think you should be aware of.

At the end of the day, it’s often best to focus on businesses with no net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.

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 shares 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 the mentioned stocks.

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