These 4 measures indicate that Sika (VTX:SIKA) uses debt safely
Warren Buffett said: “Volatility is far from synonymous with risk. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We note that Sika AG (VTX:SIKA) has debt on its balance sheet. But the real question is whether this debt makes the business risky.
What risk does debt carry?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. If things go really bad, lenders can take over the business. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. The first step when considering a company’s debt levels is to consider its cash and debt together.
Discover our latest analysis for Sika
What is Sika’s debt?
The image below, which you can click on for more details, shows that Sika had CHF 3.40 billion in debt at the end of December 2021, a reduction from CHF 3.86 billion year-on-year. On the other hand, it has 1.18 billion francs in cash, which results in a net debt of approximately 2.22 billion francs.
How strong is Sika’s balance sheet?
We can see from the most recent balance sheet that Sika had liabilities of CHF 2.09 billion due in one year, and liabilities of CHF 4.22 billion due beyond. On the other hand, it had 1.18 billion francs in cash and 1.59 billion francs in receivables at less than one year. It therefore has liabilities totaling 3.54 billion francs more than its cash and short-term receivables, combined.
Given that publicly traded Sika shares are worth a very impressive total of CHF 40.6 billion, it seems unlikely that this level of liability is a major threat. But there are enough liabilities that we certainly recommend that shareholders continue to monitor the balance sheet in the future.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
Sika’s net debt is only 1.3 times its EBITDA. And its EBIT covers its interest charges 30.7 times more. So we’re pretty relaxed about his super-conservative use of debt. Also positive, Sika has increased its EBIT by 23% over the last year, which should facilitate debt repayment in the future. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine Sika’s ability to maintain a healthy balance sheet in the future. 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 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, Sika has recorded free cash flow of 88% of its EBIT, which is higher than what we would normally expect. This puts him in a very strong position to pay off the debt.
Our point of view
Sika’s interest coverage suggests she can manage her debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. And the good news doesn’t stop there, since its conversion of EBIT into free cash flow also confirms this impression! Given this range of factors, it seems to us that Sika is quite cautious with its leverage, and the risks seem well contained. The balance sheet therefore seems rather healthy to us. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 2 warning signs for Sika you should know.
If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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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.