Is Siegfried Holding (VTX:SFZN) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Siegfried Holding AG (VTX:SFZN) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Siegfried Holding

What Is Siegfried Holding's Debt?

The chart below, which you can click on for greater detail, shows that Siegfried Holding had CHF140.0m in debt in December 2020; about the same as the year before. However, because it has a cash reserve of CHF54.4m, its net debt is less, at about CHF85.5m.

How Healthy Is Siegfried Holding's Balance Sheet?

We can see from the most recent balance sheet that Siegfried Holding had liabilities of CHF193.6m falling due within a year, and liabilities of CHF315.5m due beyond that. Offsetting these obligations, it had cash of CHF54.4m as well as receivables valued at CHF275.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CHF179.3m.

Since publicly traded Siegfried Holding shares are worth a total of CHF3.06b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Siegfried Holding has a low net debt to EBITDA ratio of only 0.64. And its EBIT covers its interest expense a whopping 29.2 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In addition to that, we're happy to report that Siegfried Holding has boosted its EBIT by 40%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Siegfried 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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Siegfried Holding's free cash flow amounted to 45% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

The good news is that Siegfried Holding's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its EBIT growth rate also supports that impression! Looking at the bigger picture, we think Siegfried Holding's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. Over time, share prices tend to follow earnings per share, so if you're interested in Siegfried Holding, you may well want to click here to check an interactive graph of its earnings per share history.

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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