Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Bayerische Motoren Werke Aktiengesellschaft (ETR:BMW) does carry debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Bayerische Motoren Werke Carry?
As you can see below, Bayerische Motoren Werke had €105.3b of debt at March 2021, down from €119.2b a year prior. However, it also had €17.9b in cash, and so its net debt is €87.4b.
How Healthy Is Bayerische Motoren Werke's Balance Sheet?
According to the last reported balance sheet, Bayerische Motoren Werke had liabilities of €75.5b due within 12 months, and liabilities of €83.0b due beyond 12 months. Offsetting this, it had €17.9b in cash and €3.00b in receivables that were due within 12 months. So it has liabilities totalling €137.6b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the €54.6b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Bayerische Motoren Werke would likely require a major re-capitalisation if it had to pay its creditors today.
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). 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).
As it happens Bayerische Motoren Werke has a fairly concerning net debt to EBITDA ratio of 8.3 but very strong interest coverage of 23.1. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. The bad news is that Bayerische Motoren Werke saw its EBIT decline by 19% over the last year. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Bayerische Motoren Werke'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, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Bayerische Motoren Werke's free cash flow amounted to 21% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
On the face of it, Bayerische Motoren Werke's net debt to EBITDA left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. After considering the datapoints discussed, we think Bayerische Motoren Werke has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example Bayerische Motoren Werke has 2 warning signs (and 1 which is a bit concerning) we think you should know about.
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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