The external fund manager backed by Berkshire Hathaway’s Charlie Munger, Li Lu, makes no bones about it when he says ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.’ So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. As with many other companies SW Umwelttechnik Stoiser & Wolschner AG (VIE:SWUT) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is SW Umwelttechnik Stoiser & Wolschner’s Net Debt?
The image below, which you can click on for greater detail, shows that SW Umwelttechnik Stoiser & Wolschner had debt of €46.8m at the end of June 2020, a reduction from €50.0m over a year. However, it does have €5.58m in cash offsetting this, leading to net debt of about €41.2m.
How Healthy Is SW Umwelttechnik Stoiser & Wolschner’s Balance Sheet?
We can see from the most recent balance sheet that SW Umwelttechnik Stoiser & Wolschner had liabilities of €27.9m falling due within a year, and liabilities of €47.4m due beyond that. On the other hand, it had cash of €5.58m and €15.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €54.5m.
The deficiency here weighs heavily on the €25.6m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we’d watch its balance sheet closely, without a doubt. After all, SW Umwelttechnik Stoiser & Wolschner would likely require a major re-capitalisation if it had to pay its creditors today.
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
SW Umwelttechnik Stoiser & Wolschner’s net debt to EBITDA ratio of about 2.3 suggests only moderate use of debt. And its strong interest cover of 13.0 times, makes us even more comfortable. Importantly, SW Umwelttechnik Stoiser & Wolschner grew its EBIT by 62% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can’t view debt in total isolation; since SW Umwelttechnik Stoiser & Wolschner will need earnings to service that debt. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, SW Umwelttechnik Stoiser & Wolschner created free cash flow amounting to 14% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.
We’d go so far as to say SW Umwelttechnik Stoiser & Wolschner’s level of total liabilities was disappointing. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making SW Umwelttechnik Stoiser & Wolschner stock a bit risky. That’s not necessarily a bad thing, but we’d generally feel more comfortable with less leverage. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it. Consider for instance, the ever-present spectre of investment risk. We’ve identified 4 warning signs with SW Umwelttechnik Stoiser & Wolschner , and understanding them should be part of your investment process.
When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
If you decide to trade SW Umwelttechnik Stoiser & Wolschner, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email firstname.lastname@example.org.