Here's Why Ackermans & Van Haaren (EBR:ACKB) Has A Meaningful Debt Burden

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Ackermans & Van Haaren NV (EBR:ACKB) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for Ackermans & Van Haaren

What Is Ackermans & Van Haaren's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Ackermans & Van Haaren had €2.42b of debt in June 2021, down from €2.87b, one year before. However, because it has a cash reserve of €1.20b, its net debt is less, at about €1.22b.

How Healthy Is Ackermans & Van Haaren's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Ackermans & Van Haaren had liabilities of €8.62b due within 12 months and liabilities of €2.95b due beyond that. Offsetting this, it had €1.20b in cash and €3.62b in receivables that were due within 12 months. So its liabilities total €6.75b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of €5.04b, we think shareholders really should watch Ackermans & Van Haaren's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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).

Ackermans & Van Haaren has net debt worth 2.2 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 5.2 times the interest expense. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. If Ackermans & Van Haaren can keep growing EBIT at last year's rate of 16% over the last year, then it will find its debt load easier to manage. 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 Ackermans & Van Haaren's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Ackermans & Van Haaren recorded free cash flow worth a fulsome 81% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

Neither Ackermans & Van Haaren's ability to handle its total liabilities 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 convert EBIT to free cash flow with ease. Looking at all the angles mentioned above, it does seem to us that Ackermans & Van Haaren is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. Case in point: We've spotted 1 warning sign for Ackermans & Van Haaren you should be aware of.

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.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.