Is Bayerische Motoren Werke (ETR:BMW) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 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.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Bayerische Motoren Werke

How Much Debt Does Bayerische Motoren Werke Carry?

The image below, which you can click on for greater detail, shows that Bayerische Motoren Werke had debt of €104.5b at the end of September 2021, a reduction from €112.1b over a year. However, it also had €14.3b in cash, and so its net debt is €90.2b.

A Look At Bayerische Motoren Werke's Liabilities

We can see from the most recent balance sheet that Bayerische Motoren Werke had liabilities of €73.9b falling due within a year, and liabilities of €78.1b due beyond that. Offsetting these obligations, it had cash of €14.3b as well as receivables valued at €2.77b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €134.9b.

This deficit casts a shadow over the €60.7b 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 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.

Strangely Bayerische Motoren Werke has a sky high EBITDA ratio of 5.6, implying high debt, but a strong interest coverage of 54.2. So either it has access to very cheap long term debt or that interest expense is going to grow! Pleasingly, Bayerische Motoren Werke is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 153% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Bayerische Motoren Werke 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Bayerische Motoren Werke recorded free cash flow of 46% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

While Bayerische Motoren Werke's level of total liabilities has us nervous. To wit both its interest cover and EBIT growth rate were encouraging signs. Taking the abovementioned factors together we do think Bayerische Motoren Werke's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Bayerische Motoren Werke you should be aware of, and 2 of them make us uncomfortable.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.