Is Semperit Holding (VIE:SEM) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Semperit Aktiengesellschaft Holding (VIE:SEM) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Semperit Holding

How Much Debt Does Semperit Holding Carry?

The image below, which you can click on for greater detail, shows that Semperit Holding had debt of €87.5m at the end of June 2022, a reduction from €170.4m over a year. But it also has €195.9m in cash to offset that, meaning it has €108.5m net cash.

How Healthy Is Semperit Holding's Balance Sheet?

We can see from the most recent balance sheet that Semperit Holding had liabilities of €268.2m falling due within a year, and liabilities of €128.8m due beyond that. Offsetting these obligations, it had cash of €195.9m as well as receivables valued at €148.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €52.6m.

Of course, Semperit Holding has a market capitalization of €374.0m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Semperit Holding boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Semperit Holding if management cannot prevent a repeat of the 62% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Semperit Holding can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Semperit Holding 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 most recent three years, Semperit Holding recorded free cash flow worth 80% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While Semperit Holding does have more liabilities than liquid assets, it also has net cash of €108.5m. The cherry on top was that in converted 80% of that EBIT to free cash flow, bringing in €68m. So we are not troubled with Semperit Holding's debt use. 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. For example Semperit Holding has 3 warning signs (and 1 which shouldn't be ignored) 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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.