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. When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Schlatter Industries AG (VTX:STRN) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company’s use of debt, we first look at cash and debt together.
How Much Debt Does Schlatter Industries Carry?
The image below, which you can click on for greater detail, shows that at June 2019 Schlatter Industries had debt of CHF1.46m, up from CHF470.0k in one year. But it also has CHF2.39m in cash to offset that, meaning it has CHF934.0k net cash.
How Strong Is Schlatter Industries’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Schlatter Industries had liabilities of CHF24.5m due within 12 months and liabilities of CHF4.98m due beyond that. Offsetting these obligations, it had cash of CHF2.39m as well as receivables valued at CHF26.7m due within 12 months. So these liquid assets roughly match the total liabilities.
Having regard to Schlatter Industries’s size, it seems that its liquid assets are well balanced with its total liabilities. So it’s very unlikely that the CHF38.0m company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Schlatter Industries also has more cash than debt, so we’re pretty confident it can manage its debt safely.
Also good is that Schlatter Industries grew its EBIT at 17% over the last year, further increasing its ability to manage debt. There’s no doubt that we learn most about debt from the balance sheet. But it is Schlatter Industries’s earnings that will influence how the balance sheet holds up in the future. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. Schlatter Industries may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Schlatter Industries saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
We could understand if investors are concerned about Schlatter Industries’s liabilities, but we can be reassured by the fact it has has net cash of CHF934.0k. And we liked the look of last year’s 17% year-on-year EBIT growth. So we don’t have any problem with Schlatter Industries’s use of debt. 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 – Schlatter Industries has 3 warning signs (and 1 which can’t be ignored) we think you should know about.
Of course, if you’re the type of investor who prefers buying stocks without the burden of debt, then don’t hesitate to discover our exclusive list of net cash growth stocks, today.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.