Here's Why Hensoldt (ETR:HAG) Can Manage Its Debt Responsibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Hensoldt AG (ETR:HAG) does carry debt. But the real question is whether this debt is making the company risky.

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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. 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, 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.

How Much Debt Does Hensoldt Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2024 Hensoldt had €1.10b of debt, an increase on €646.0m, over one year. However, it also had €734.0m in cash, and so its net debt is €361.0m.

A Look At Hensoldt's Liabilities

According to the last reported balance sheet, Hensoldt had liabilities of €1.88b due within 12 months, and liabilities of €1.93b due beyond 12 months. Offsetting this, it had €734.0m in cash and €860.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €2.22b.

While this might seem like a lot, it is not so bad since Hensoldt has a market capitalization of €6.51b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

View our latest analysis for Hensoldt

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Looking at its net debt to EBITDA of 1.4 and interest cover of 2.7 times, it seems to us that Hensoldt is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. One way Hensoldt could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 14%, as it did over the last year. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Hensoldt 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 .

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, Hensoldt recorded free cash flow worth a fulsome 82% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

Happily, Hensoldt's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But we must concede we find its interest cover has the opposite effect. Looking at all the aforementioned factors together, it strikes us that Hensoldt can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Hensoldt (of which 1 is a bit unpleasant!) you should know about.

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.