We Think Josef Manner & Comp (VIE:MAN) Is Taking Some Risk With Its Debt

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. We note that Josef Manner & Comp. AG (VIE:MAN) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Josef Manner & Comp

What Is Josef Manner & Comp's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 Josef Manner & Comp had €53.1m of debt, an increase on €49.2m, over one year. However, because it has a cash reserve of €2.20m, its net debt is less, at about €50.9m.

How Strong Is Josef Manner & Comp's Balance Sheet?

We can see from the most recent balance sheet that Josef Manner & Comp had liabilities of €30.3m falling due within a year, and liabilities of €68.1m due beyond that. Offsetting these obligations, it had cash of €2.20m as well as receivables valued at €31.6m due within 12 months. So its liabilities total €64.6m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Josef Manner & Comp is worth €204.1m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Josef Manner & Comp has a debt to EBITDA ratio of 3.4, which signals significant debt, but is still pretty reasonable for most types of business. But its EBIT was about 10.1 times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. If Josef Manner & Comp can keep growing EBIT at last year's rate of 11% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Josef Manner & Comp 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Josef Manner & Comp recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

Neither Josef Manner & Comp's ability to convert EBIT to free cash flow nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. We think that Josef Manner & Comp's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Josef Manner & Comp is showing 1 warning sign in our investment analysis , 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.

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