Is hGears (ETR:HGEA) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that hGears AG (ETR:HGEA) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for hGears

What Is hGears's Net Debt?

The chart below, which you can click on for greater detail, shows that hGears had €20.1m in debt in December 2023; about the same as the year before. However, its balance sheet shows it holds €26.6m in cash, so it actually has €6.52m net cash.

How Strong Is hGears' Balance Sheet?

The latest balance sheet data shows that hGears had liabilities of €54.0m due within a year, and liabilities of €8.96m falling due after that. Offsetting this, it had €26.6m in cash and €14.2m in receivables that were due within 12 months. So it has liabilities totalling €22.2m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of €26.7m, so it does suggest shareholders should keep an eye on hGears' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, hGears boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if hGears 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, hGears made a loss at the EBIT level, and saw its revenue drop to €114m, which is a fall of 17%. That's not what we would hope to see.

So How Risky Is hGears?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And the fact is that over the last twelve months hGears lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through €4.1m of cash and made a loss of €14m. But the saving grace is the €6.52m on the balance sheet. That kitty means the company can keep spending for growth for at least two years, at current rates. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. 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 1 warning sign for hGears you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.