We Think Better Collective (STO:BETCO) can stay on top of its 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 may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We can see that Best Collective A/S (STO: BETCO) uses debt in his business. But the more important question is: what risk does this debt create?
When is debt a problem?
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. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first step when considering a company’s debt levels is to consider its cash and debt together.
What is Better Collective’s Net Debt?
The image below, which you can click on for more details, shows that in June 2022, Better Collective had a debt of 249.7 million euros, compared to 126.6 million euros in one year. However, because it has a cash reserve of €33.0 million, its net debt is lower, at around €216.7 million.
A look at the responsibilities of Better Collective
The latest balance sheet data shows that Better Collective had liabilities of €93.7 million due within the year, and liabilities of €267.6 million due thereafter. On the other hand, it had €33.0 million in cash and €34.5 million in receivables at less than one year. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables by €293.8 million.
This shortfall is not that bad as Better Collective is worth €741.6 million and therefore could probably raise enough capital to shore up its balance sheet, should the need arise. But we definitely want to keep our eyes peeled for indications that its debt is too risky.
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). 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 ).
Better Collective has a debt to EBITDA ratio of 3.6, which signals significant debt, but is still fairly reasonable for most types of businesses. But its EBIT was about 1,000 times its interest expense, implying that the company isn’t really paying a high cost to maintain that level of leverage. Even if the low cost turns out to be unsustainable, that’s a good sign. We note that Better Collective has grown its EBIT by 27% over the past year, which should make it easier to pay down debt in the future. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Better Collective can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecasts.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Better Collective has burned a lot of money. While this may be the result of spending for growth, it makes debt much riskier.
Our point of view
Better Collective’s conversion of EBIT to free cash flow was a real negative in this analysis, even though the other factors we considered were considerably better. There is no doubt that its ability to cover its interest costs with its EBIT is quite flashy. Looking at all this data, we feel a bit cautious about Better Collective’s debt levels. While debt has its upside in higher potential returns, we think shareholders should certainly consider how debt levels could make the stock more risky. 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. To do this, you need to find out about the 2 warning signs we spotted with Better Collective (including 1 that is concerning) .
Of course, if you are the type of investor who prefers to buy stocks without going into debt, do not hesitate to discover our exclusive list of net cash growth stockstoday.
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Find out if Better Collective is potentially overvalued or undervalued by viewing our full analysis, which includes fair value estimates, risks and warnings, dividends, insider trading and financial health.
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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.