Is Strabag (VIE:STR) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 can see that Strabag SE (VIE:STR) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Strabag

What Is Strabag's Debt?

As you can see below, Strabag had €1.06b of debt at June 2022, down from €1.16b a year prior. But it also has €1.88b in cash to offset that, meaning it has €819.6m net cash.

A Look At Strabag's Liabilities

We can see from the most recent balance sheet that Strabag had liabilities of €6.21b falling due within a year, and liabilities of €2.05b due beyond that. Offsetting these obligations, it had cash of €1.88b as well as receivables valued at €3.67b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €2.70b.

This deficit is considerable relative to its market capitalization of €4.03b, so it does suggest shareholders should keep an eye on Strabag's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, Strabag also has more cash than debt, so we're pretty confident it can manage its debt safely.

And we also note warmly that Strabag grew its EBIT by 10% last year, making its debt load easier to handle. 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 Strabag 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Strabag 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, Strabag recorded free cash flow worth a fulsome 99% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

Although Strabag's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €819.6m. The cherry on top was that in converted 99% of that EBIT to free cash flow, bringing in €136m. So we don't have any problem with Strabag's use of debt. 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, we've discovered 2 warning signs for Strabag (1 is significant!) that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.