Does Progress-Werk Oberkirch (ETR:PWO) Have A Healthy Balance Sheet?

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 Progress-Werk Oberkirch AG (ETR:PWO) does use debt in its business. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Progress-Werk Oberkirch

What Is Progress-Werk Oberkirch's Debt?

The image below, which you can click on for greater detail, shows that Progress-Werk Oberkirch had debt of €104.1m at the end of September 2020, a reduction from €149.5m over a year. However, it does have €14.3m in cash offsetting this, leading to net debt of about €89.8m.

A Look At Progress-Werk Oberkirch's Liabilities

We can see from the most recent balance sheet that Progress-Werk Oberkirch had liabilities of €140.8m falling due within a year, and liabilities of €130.8m due beyond that. Offsetting these obligations, it had cash of €14.3m as well as receivables valued at €96.6m due within 12 months. So its liabilities total €160.7m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the €66.3m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Progress-Werk Oberkirch 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Progress-Werk Oberkirch's debt to EBITDA ratio (3.3) suggests that it uses some debt, its interest cover is very weak, at 0.47, suggesting high leverage. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Even worse, Progress-Werk Oberkirch saw its EBIT tank 89% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Progress-Werk Oberkirch'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Progress-Werk Oberkirch actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

On the face of it, Progress-Werk Oberkirch's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Overall, it seems to us that Progress-Werk Oberkirch's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Progress-Werk Oberkirch (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

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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