Is Metro (ETR: B4B) a risky investment?

Howard Marks put it well when he said that, rather than worrying about stock price volatility, “The possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried. ” It is only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. Like many other companies Metro SA (ETR: B4B) uses debt. But should shareholders be concerned about its use of debt?

Why Does Debt Bring Risk?

Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we think of a business’s use of debt, we first look at cash flow and debt together.

See our latest analysis for Metro

What is Metro Debt?

You can click on the graph below for the historical figures, but it shows that Metro had 5.12 billion euros in debt in June 2021, down from 6.44 billion euros a year earlier. However, because it has a cash reserve of 1.85 billion euros, its net debt is less, at around 3.27 billion euros.

XTRA: B4B Debt to Equity History September 18, 2021

A look at Metro’s responsibilities

According to the latest published balance sheet, Metro had liabilities of 6.17 billion euros within 12 months and liabilities of 4.70 billion euros due beyond 12 months. In compensation for these commitments, he had cash of € 1.85 billion as well as receivables valued at € 580.0 million within 12 months. Its liabilities therefore amount to € 8.44 billion more than the combination of its cash and short-term receivables.

The deficit here weighs heavily on the 3.89 billion euro company itself, as if a child struggles under the weight of a huge backpack full of books, his sports equipment and a trumpet. . So we would be watching its record closely, without a doubt. Ultimately, Metro would likely need a major recapitalization if its creditors demanded repayment.

We measure a company’s debt load relative to its earning capacity 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 costs (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 we’re not worried about Metro’s net debt to EBITDA ratio of 3.8, we do think its ultra-low 2.2x interest coverage is a sign of high leverage. It appears the company incurs significant depreciation and amortization costs, so perhaps its debt load is heavier than it first appears, since EBITDA is arguably a generous measure of profits. It seems clear that the cost of borrowing money is having a negative impact on shareholder returns lately. The good news is that Metro has increased its EBIT by 45% over the past twelve months. Like a mother’s loving embrace of a newborn, this type of growth builds resilience, putting the business in a stronger position to manage debt. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Metro’s ability to maintain a healthy balance sheet going forward. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, while the IRS may love accounting profits, lenders only accept hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Metro has actually generated more free cash flow than EBIT. This kind of solid money conversion makes us as excited as the crowd when the beat drops at a Daft Punk concert.

Our point of view

We feel some trepidation about the difficulty level of Metro’s total liabilities, but we also have some bright spots to focus on. For example, its conversion from EBIT to free cash flow and the growth rate of EBIT give us some confidence in its ability to manage its debt. Taking the above factors together, we believe that Metro’s debt poses certain risks to the business. So while this leverage increases returns on equity, we wouldn’t really want to see it increase from here. The balance sheet is clearly the area you need to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. Note that Metro displays 4 warning signs in our investment analysis , and 1 of them is a bit disturbing …

Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.

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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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