OC Oerlikon (VTX:OERL) Has A Pretty Healthy Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 OC Oerlikon Corporation AG (VTX:OERL) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for OC Oerlikon

What Is OC Oerlikon's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2021 OC Oerlikon had debt of CHF748.0m, up from CHF165.0m in one year. On the flip side, it has CHF619.0m in cash leading to net debt of about CHF129.0m.

A Look At OC Oerlikon's Liabilities

Zooming in on the latest balance sheet data, we can see that OC Oerlikon had liabilities of CHF1.52b due within 12 months and liabilities of CHF1.35b due beyond that. Offsetting these obligations, it had cash of CHF619.0m as well as receivables valued at CHF673.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CHF1.58b.

This is a mountain of leverage relative to its market capitalization of CHF2.37b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

OC Oerlikon's net debt is only 0.37 times its EBITDA. And its EBIT easily covers its interest expense, being 21.9 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Even more impressive was the fact that OC Oerlikon grew its EBIT by 994% over twelve months. That boost will make it even easier to pay down debt going forward. 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 OC Oerlikon'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, OC Oerlikon actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

The good news is that OC Oerlikon's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its level of total liabilities. Zooming out, OC Oerlikon seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. Given OC Oerlikon has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.

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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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.