Here's Why LEM Holding (VTX:LEHN) Can Manage Its Debt Responsibly
David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies LEM Holding SA (VTX:LEHN) makes use of debt. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for LEM Holding
What Is LEM Holding's Net Debt?
The image below, which you can click on for greater detail, shows that at March 2023 LEM Holding had debt of CHF43.6m, up from CHF40.7m in one year. On the flip side, it has CHF21.8m in cash leading to net debt of about CHF21.8m.
How Healthy Is LEM Holding's Balance Sheet?
We can see from the most recent balance sheet that LEM Holding had liabilities of CHF114.9m falling due within a year, and liabilities of CHF39.0m due beyond that. On the other hand, it had cash of CHF21.8m and CHF90.4m worth of receivables due within a year. So its liabilities total CHF41.7m more than the combination of its cash and short-term receivables.
Having regard to LEM Holding's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CHF2.47b company is struggling for cash, we still think it's worth monitoring its balance sheet. But either way, LEM 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.
LEM Holding has a low net debt to EBITDA ratio of only 0.21. And its EBIT covers its interest expense a whopping 80.2 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The good news is that LEM Holding has increased its EBIT by 4.3% over twelve months, which should ease any concerns about debt repayment. 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 LEM 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, LEM Holding recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Our View
LEM Holding's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its net debt to EBITDA is also very heartening. Taking all this data into account, it seems to us that LEM Holding takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that LEM Holding is showing 1 warning sign in our investment analysis , 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. 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.
About SWX:LEHN
LEM Holding
Provides solutions for measuring electrical parameters in China, Japan, South Korea, India, Southeast Asia, Europe, Middle East, Africa, NAFTA and Latin America.
Undervalued with high growth potential and pays a dividend.