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. Above all, Spark Networks SE (NASDAQ:LOV) is in debt. But the real question is whether this debt makes the business risky.
Why is debt risky?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. If things go really bad, lenders can take over the business. 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. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
Check out our latest analysis for Spark Networks
How much debt does Spark Networks have?
As you can see below, Spark Networks had $106.1 million in debt as of March 2022, roughly the same as the year before. You can click on the graph for more details. On the other hand, he has $13.0 million in cash, resulting in a net debt of around $93.1 million.
How healthy is Spark Networks’ balance sheet?
Zooming in on the latest balance sheet data, we can see that Spark Networks had liabilities of US$63.8 million due within 12 months and liabilities of US$113.5 million due beyond. In compensation for these obligations, it had cash of US$13.0 million as well as receivables valued at US$5.75 million and maturing within 12 months. Thus, its liabilities total $158.5 million more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the $87.0 million business, like a colossus towering above mere mortals. We would therefore be watching his balance sheet closely, no doubt. After all, Spark Networks would likely need a major recapitalization if it were to pay its creditors today.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
While we’re not concerned about Spark Networks’ net debt to EBITDA ratio of 3.7, we believe its extremely low interest coverage of 1.2x is a sign of high leverage. It seems clear that the cost of borrowing money is having a negative impact on shareholder returns lately. On a lighter note, Spark Networks has increased its EBIT by 27% over the past year. If he can sustain that kind of improvement, his debt load will start to melt like glaciers in a warming world. 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 Spark Networks 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 forecast.
Finally, a company can only repay its debts with cold hard cash, not with book profits. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Spark Networks has produced strong free cash flow equivalent to 60% of its EBIT, which is what we expected. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
At first glance, Spark Networks’ interest coverage left us hesitant about the stock, and its level of total liabilities was no more appealing than the single empty restaurant on the busiest night of the year. But at least it’s decent enough to increase its EBIT; it’s encouraging. Once we consider all of the above factors together, it seems to us that Spark Networks’ debt makes it a bit risky. Some people like that kind of risk, but we’re aware of the potential pitfalls, so we’d probably prefer it to take on 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 outside of the balance sheet. We have identified 3 warning signs with Spark Networks (at least 1 which we don’t like too much), and understanding them should be part of your investment process.
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% freeat present.
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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.