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.' 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 Stadler Rail AG (VTX:SRAIL) makes use of debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Stadler Rail's Debt?
You can click the graphic below for the historical numbers, but it shows that Stadler Rail had CHF956.9m of debt in June 2023, down from CHF1.38b, one year before. On the flip side, it has CHF899.1m in cash leading to net debt of about CHF57.8m.
How Healthy Is Stadler Rail's Balance Sheet?
The latest balance sheet data shows that Stadler Rail had liabilities of CHF3.17b due within a year, and liabilities of CHF710.3m falling due after that. Offsetting these obligations, it had cash of CHF899.1m as well as receivables valued at CHF1.13b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CHF1.86b.
Stadler Rail has a market capitalization of CHF3.49b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.
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).
Stadler Rail's net debt is only 0.22 times its EBITDA. And its EBIT covers its interest expense a whopping 16.7 times over. So we're pretty relaxed about its super-conservative use of debt. But the bad news is that Stadler Rail has seen its EBIT plunge 14% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Stadler Rail'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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Stadler Rail actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Stadler Rail's interest cover was a real positive on this analysis, as was its conversion of EBIT to free cash flow. But truth be told its EBIT growth rate had us nibbling our nails. When we consider all the elements mentioned above, it seems to us that Stadler Rail is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. We've identified 1 warning sign with Stadler Rail , and understanding them should be part of your investment process.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.
Stadler Rail AG, through its subsidiaries, engages in the manufacture and sale of trains in Switzerland, Germany, Austria, Western and Eastern Europe, the Americas, the CIS countries, and internationally.
High growth potential with excellent balance sheet.