Assessing a company’s leverage

In last week’s article I stressed on the importance for a company to have sufficient equity in order to maintain reasonable levels of leverage. International credit rating agencies typically use a defined methodology to rate a corporate bond issuer. One of the components of the methodology 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 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 earnings before interest, taxes, depreciation, and amortization (EBITDA). The ratio calculates the number of years it would take for 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 mentioned this ratio several times in my articles over the years and 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 which are then updated annually as per the MFSA requirements. As such, investors can often gauge the extent of leverage of companies in which they have exposure to or contemplating an investment in by referring to the Financial Analysis Summary.

Most companies listed across 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 across various sectors due to the different business models among industries, a ratio of below 2 times is considered to be a very healthy level showing the low leverage of that particular company.

A ratio of between 2 times and 4 times is normally considered a moderate level of leverage which 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.

The graph being published today displays the data of selected issuers only 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 there are a number of companies with 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 and it is also useful to compare the ratios of Maltese companies with the much larger companies within the same sector that are rated by the international rating agencies and are classified as ‘investment grade’. Companies within 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 need to also consider that these ratios provide a snapshot over a short timeframe which 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 an investment in a new bond or one that is 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.

Undoubtedly, despite these requirements, it is 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 and this is why annual reviews of a company’s financial statements are important. Such a review would immediately indicate whether a company possesses 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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