Is Bayerische Motoren Werke (ETR:BMW) 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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Bayerische Motoren Werke Aktiengesellschaft (ETR:BMW) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Bayerische Motoren Werke

What Is Bayerische Motoren Werke's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Bayerische Motoren Werke had €102.7b of debt in December 2020, down from €111.7b, one year before. However, it does have €15.8b in cash offsetting this, leading to net debt of about €86.9b.

A Look At Bayerische Motoren Werke's Liabilities

According to the last reported balance sheet, Bayerische Motoren Werke had liabilities of €72.0b due within 12 months, and liabilities of €83.2b due beyond 12 months. On the other hand, it had cash of €15.8b and €2.74b worth of receivables due within a year. So its liabilities total €136.6b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the €55.9b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Bayerische Motoren Werke would probably need a major re-capitalization if its creditors were to demand repayment.

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.

As it happens Bayerische Motoren Werke has a fairly concerning net debt to EBITDA ratio of 9.9 but very strong interest coverage of 15.8. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Shareholders should be aware that Bayerische Motoren Werke's EBIT was down 45% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Bayerische Motoren Werke can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Over the last three years, Bayerische Motoren Werke reported free cash flow worth 5.1% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

To be frank both Bayerische Motoren Werke's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. 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. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Bayerische Motoren Werke (at least 1 which doesn't sit too well with us) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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