Financial analysis: Assessing a company’s leverage
In last week’s article, I stressed the importance for a company to have sufficient equity to maintain reasonable levels of leverage.
International credit rating agencies typically use a defined methodology to rate a corporate bond issuer. One of the methodology’s components is a financial risk assessment wherein companies are tested using a number of financial ratios.
Apart from the debt-to-equity ratio to assess the extent of leverage with the level of equity compared to debt as a main consideration on a company’s financial strength, another ratio used to measure leverage is the net debt-to-EBITDA (earnings before interest, taxes, depreciation and amortisation) multiple. This is widely used internationally and also mentioned frequently in the investor decks provided by large companies overseas.
This ratio measures a company’s debt burden relative to its EBITDA. The ratio calculates the number of years it would take a company to pay off its entire debt burden, assuming the present level of earnings remains unchanged.
As such, a low ratio indicates that a company can easily pay-off its debt while a high ratio provides a clear warning to investors that a company has a high debt burden relative to its earnings, and therefore exposed to the risk of refinancing.
I have mentioned this ratio several times in my articles over the years, and I have also regularly published such ratios of bonds issuers across various sectors as a comparison. Moreover, this measure of leverage is now also displayed in the financial analysis summaries published for new bond issues that are then updated annually as per the MFSA requirements. As such, investors can often gauge the extent of leverage of companies to which they are exposed or that they are contemplating investing in by referring to the financial analysis summary.
Investors can often gauge the extent of leverage of companies to which they are exposed or that they are contemplating investing in by referring to the financial analysis summary
Most companies listed in the international financial markets have clear parameters on their leverage policies, and during their meetings with financial analysts, they regularly display their net debt-to-EBITDA multiple against their guidelines.
Although such ratios cannot be used in various sectors due to the different business models among industries, a ratio of below 2 times is considered a very healthy level, showing the low leverage of that particular company.
A ratio of between 2 and 4 times is normally considered a moderate level of leverage that is generally acceptable across many sectors. Meanwhile, a net debt-to-EBITDA multiple of above 4 times is often seen as high risk, especially for companies operating in cyclical industries.
In certain sectors, such as utilities, telecoms and infrastructure, where companies generally have high visibility of stable cash flows, a higher level of leverage of above 5 times is generally sustainable, especially when most of their debt matures in the long term.
Bond issuers in Malta are obliged by regulation to publish their annual financial statements within four months of their financial year-end and their updated financial analysis summary within two months thereafter. With such information publicly available, one can easily collect the data necessary to calculate the leverage ratios of domestic bond issuers and/or their guarantors.
The above graph displays the data of selected issuers for the past financial year and the current financial year, as published in the financial analysis summary of each issuer. It is immediately evident that a number of companies have a net debt to EBITDA multiple of below 5 times both from a historic perspective (2024) and also for 2025, which is reassuring for the investing public.
I have often cited the low leverage of Simonds Farsons Cisk plc. It is also useful to compare the ratios of Maltese companies with the much-larger companies in the same sector that are rated by the international rating agencies and are classified as ‘investment grade’.
Companies in the beverage sector, such as Pepsico Inc, Anheuser-Busch Inbev and Carlsberg Breweries, all have a net debt-to-EBITDA multiple ranging between 3.2 times and 3.5 times, with good credit ratings, while that of Farsons is of only 1.1 times.
Investors also need to consider that these ratios provide a snapshot over a short timeframe that may be distorted by certain events or impacted by specific business cycles.
For example, SD Holdings Ltd (as guarantor of SD Finance plc) incurred significant debt in recent years to finance the development of the DB City Centre, which will result in future one-off income through property sales, as well as an additional recurring income from the upcoming Hard Rock Hotel, shopping mall and other amenities.
Investors should consider a company’s leverage not only when contemplating investing in a new bond or in one already listed on the stock exchange, but also review this at least on an annual basis for those companies in which they are already exposed to within their investment portfolio.
The regulatory obligations are sufficiently robust to ensure that all the information is made available publicly for investors to take the right decision.
Despite these requirements, it is undoubtedly inevitable for some companies to face challenging situations over time. While this may be disappointing for investors and lead to higher levels of anxiety, such challenges do not occur overnight. This is why annual reviews of a company’s financial statements are important. Such a review would immediately indicate whether a company has adequate financial strength or whether they have too much leverage and can suffer challenges in the future to honour their obligations.
This should be one of the main focal points by the investor community in the weeks and months ahead as several new bond issues are launched.
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