Howard Marks put it nicely when he said that, rather than worrying about share price volatility, ‘The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that thyssenkrupp AG (ETR:TKA) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is thyssenkrupp’s Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2020 thyssenkrupp had €9.05b of debt, an increase on €7.66b, over one year. However, because it has a cash reserve of €2.30b, its net debt is less, at about €6.76b.
A Look At thyssenkrupp’s Liabilities
According to the last reported balance sheet, thyssenkrupp had liabilities of €20.9b due within 12 months, and liabilities of €13.9b due beyond 12 months. On the other hand, it had cash of €2.30b and €5.51b worth of receivables due within a year. So its liabilities total €27.0b more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the €3.87b company, like a colossus towering over mere mortals. So we’d watch its balance sheet closely, without a doubt. At the end of the day, thyssenkrupp would probably need a major re-capitalization if its creditors were to demand repayment. There’s no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if thyssenkrupp can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Over 12 months, thyssenkrupp reported revenue of €41b, which is a gain of 8.3%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Importantly, thyssenkrupp had negative earnings before interest and tax (EBIT), over the last year. Indeed, it lost a very considerable €685m at the EBIT level. Reflecting on this and the significant total liabilities, it’s hard to know what to say about the stock because of our intense dis-affinity for it. Sure, the company might have a nice story about how they are going on to a brighter future. But the reality is that it is low on liquid assets relative to liabilities, and it burned through €1.5b in the last year. So we consider this a high risk stock, and we’re worried its share price could sink faster than than a dingy with a great white shark attacking it. There’s no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example – thyssenkrupp has 2 warning signs (and 1 which is concerning) we think you should know about.
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.
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