Is Continental (ETR:CON) Using Debt Sensibly?

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, Continental Aktiengesellschaft (ETR:CON) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Continental

What Is Continental's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Continental had €6.16b of debt, an increase on €5.23b, over one year. However, because it has a cash reserve of €1.91b, its net debt is less, at about €4.25b.

How Strong Is Continental's Balance Sheet?

We can see from the most recent balance sheet that Continental had liabilities of €15.5b falling due within a year, and liabilities of €7.65b due beyond that. Offsetting these obligations, it had cash of €1.91b as well as receivables valued at €8.61b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €12.6b.

When you consider that this deficiency exceeds the company's huge €11.0b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Continental'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.

In the last year Continental wasn't profitable at an EBIT level, but managed to grow its revenue by 2.4%, to €36b. 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 €834m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through €732m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Continental that you should be aware of before investing here.

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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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.