Here's Why CPH Chemie + Papier Holding (VTX:CPHN) Can Manage Its Debt Responsibly

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. As with many other companies CPH Chemie + Papier Holding AG (VTX:CPHN) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 CPH Chemie + Papier Holding

What Is CPH Chemie + Papier Holding's Debt?

The chart below, which you can click on for greater detail, shows that CPH Chemie + Papier Holding had CHF117.3m in debt in December 2020; about the same as the year before. However, it does have CHF116.3m in cash offsetting this, leading to net debt of about CHF1.03m.

A Look At CPH Chemie + Papier Holding's Liabilities

Zooming in on the latest balance sheet data, we can see that CPH Chemie + Papier Holding had liabilities of CHF89.6m due within 12 months and liabilities of CHF142.8m due beyond that. On the other hand, it had cash of CHF116.3m and CHF70.1m worth of receivables due within a year. So its liabilities total CHF46.0m more than the combination of its cash and short-term receivables.

Given CPH Chemie + Papier Holding has a market capitalization of CHF400.8m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. But either way, CPH Chemie + Papier Holding has virtually no net debt, so it's fair to say it does not have a heavy debt load!

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

CPH Chemie + Papier Holding has very modest net debt, giving rise to a debt to EBITDA ratio of 0.019. And this impression is enhanced by its strong EBIT which covers interest costs 9.3 times. In fact CPH Chemie + Papier Holding's saving grace is its low debt levels, because its EBIT has tanked 56% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine CPH Chemie + Papier Holding'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, CPH Chemie + Papier Holding generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

The good news is that CPH Chemie + Papier Holding's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its EBIT growth rate. Looking at all the aforementioned factors together, it strikes us that CPH Chemie + Papier Holding can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. For example CPH Chemie + Papier Holding has 3 warning signs (and 1 which is significant) we think 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.

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This article by Simply Wall St is general in nature. 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.
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