Health Check: How Prudently Does Continental (ETR:CON) Use Debt?

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. Importantly, Continental Aktiengesellschaft (ETR:CON) does carry debt. But the real question is whether this debt is making the company risky.

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Continental

What Is Continental's Net Debt?

As you can see below, Continental had €6.65b of debt, at March 2022, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has €2.32b in cash leading to net debt of about €4.33b.

A Look At Continental's Liabilities

Zooming in on the latest balance sheet data, we can see that Continental had liabilities of €14.0b due within 12 months and liabilities of €9.65b due beyond that. On the other hand, it had cash of €2.32b and €8.23b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €13.1b.

This is a mountain of leverage even relative to its gargantuan market capitalization of €14.5b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. 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 Continental 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.

Over 12 months, Continental reported revenue of €34b, which is a gain of 7.6%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Importantly, Continental had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at €195m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Surprisingly, we note that it actually reported positive free cash flow of €536m and a profit of €1.1b. So one might argue that there's still a chance it can get things on the right track. 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. For example, we've discovered 1 warning sign for Continental that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.