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

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. As with many other companies Progress-Werk Oberkirch AG (ETR:PWO) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. 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

How Much Debt Does Progress-Werk Oberkirch Carry?

You can click the graphic below for the historical numbers, but it shows that Progress-Werk Oberkirch had €119.7m of debt in June 2020, down from €145.3m, one year before. However, it also had €18.6m in cash, and so its net debt is €101.1m.

A Look At Progress-Werk Oberkirch's Liabilities

The latest balance sheet data shows that Progress-Werk Oberkirch had liabilities of €137.0m due within a year, and liabilities of €127.6m falling due after that. Offsetting these obligations, it had cash of €18.6m as well as receivables valued at €87.2m due within 12 months. So its liabilities total €158.9m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the €52.2m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Progress-Werk Oberkirch would likely require a major re-capitalisation if it had to pay its creditors today.

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). 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 (2.9) suggests that it uses some debt, its interest cover is very weak, at 2.0, 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 36% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. 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 Progress-Werk Oberkirch can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

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 on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. We're quite clear that we consider Progress-Werk Oberkirch to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 4 warning signs for Progress-Werk Oberkirch you should be aware of, and 1 of them is significant.

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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