Stock Analysis

Is Burckhardt Compression Holding (VTX:BCHN) A Risky Investment?

SWX:BCHN
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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. We can see that Burckhardt Compression Holding AG (VTX:BCHN) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Burckhardt Compression Holding

How Much Debt Does Burckhardt Compression Holding Carry?

The image below, which you can click on for greater detail, shows that Burckhardt Compression Holding had debt of CHF178.0m at the end of September 2021, a reduction from CHF208.3m over a year. On the flip side, it has CHF126.6m in cash leading to net debt of about CHF51.4m.

debt-equity-history-analysis
SWX:BCHN Debt to Equity History February 19th 2022

How Healthy Is Burckhardt Compression Holding's Balance Sheet?

According to the last reported balance sheet, Burckhardt Compression Holding had liabilities of CHF459.1m due within 12 months, and liabilities of CHF161.5m due beyond 12 months. On the other hand, it had cash of CHF126.6m and CHF285.4m worth of receivables due within a year. So its liabilities total CHF208.5m more than the combination of its cash and short-term receivables.

Given Burckhardt Compression Holding has a market capitalization of CHF1.42b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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).

Burckhardt Compression Holding has a low net debt to EBITDA ratio of only 0.50. And its EBIT easily covers its interest expense, being 13.7 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On the other hand, Burckhardt Compression Holding saw its EBIT drop by 3.3% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Burckhardt Compression Holding can strengthen its balance sheet over time. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Burckhardt Compression Holding generated free cash flow amounting to a very robust 89% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

The good news is that Burckhardt Compression Holding's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its EBIT growth rate does undermine this impression a bit. Zooming out, Burckhardt Compression Holding seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Burckhardt Compression Holding you should know about.

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.

Valuation is complex, but we're here to simplify it.

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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.