Here's Why LEONI (ETR:LEO) Is Weighed Down By Its Debt Load

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. We can see that LEONI AG (ETR:LEO) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 LEONI

How Much Debt Does LEONI Carry?

The image below, which you can click on for greater detail, shows that at September 2021 LEONI had debt of €1.76b, up from €1.68b in one year. However, it does have €138.1m in cash offsetting this, leading to net debt of about €1.62b.

How Healthy Is LEONI's Balance Sheet?

We can see from the most recent balance sheet that LEONI had liabilities of €1.42b falling due within a year, and liabilities of €1.87b due beyond that. Offsetting this, it had €138.1m in cash and €567.3m in receivables that were due within 12 months. So its liabilities total €2.59b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the €361.0m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, LEONI 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.

Weak interest cover of 0.50 times and a disturbingly high net debt to EBITDA ratio of 8.4 hit our confidence in LEONI like a one-two punch to the gut. The debt burden here is substantial. However, the silver lining was that LEONI achieved a positive EBIT of €30m in the last twelve months, an improvement on the prior year's loss. 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 LEONI's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, LEONI saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both LEONI's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least its EBIT growth rate is not so bad. We think the chances that LEONI has too much debt a very significant. To our minds, that means the stock is rather high risk, and probably one to avoid; but to each their own (investing) style. While LEONI didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away. Click here to see if its earnings are heading in the right direction, over the medium term.

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.