Is Lenzing (VIE:LNZ) Using Debt In A Risky Way?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Lenzing Aktiengesellschaft (VIE:LNZ) does use debt in its business. But the real question is whether this debt is making the company risky.

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Lenzing

What Is Lenzing's Net Debt?

The chart below, which you can click on for greater detail, shows that Lenzing had €2.47b in debt in September 2023; about the same as the year before. However, because it has a cash reserve of €747.7m, its net debt is less, at about €1.72b.

How Healthy Is Lenzing's Balance Sheet?

The latest balance sheet data shows that Lenzing had liabilities of €1.16b due within a year, and liabilities of €2.46b falling due after that. Offsetting these obligations, it had cash of €747.7m as well as receivables valued at €322.4m due within 12 months. So its liabilities total €2.55b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the €1.42b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Lenzing would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Lenzing's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Lenzing had a loss before interest and tax, and actually shrunk its revenue by 4.5%, to €2.5b. We would much prefer see growth.

Caveat Emptor

Importantly, Lenzing had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at €122m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through €384m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Lenzing is showing 3 warning signs in our investment analysis , and 2 of those are concerning...

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.