These 4 Measures Indicate That Heidelberger Druckmaschinen (ETR:HDD) Is Using Debt Extensively

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. Importantly, Heidelberger Druckmaschinen Aktiengesellschaft (ETR:HDD) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Our analysis indicates that HDD is potentially undervalued!

What Is Heidelberger Druckmaschinen's Net Debt?

The image below, which you can click on for greater detail, shows that Heidelberger Druckmaschinen had debt of €143.0m at the end of June 2022, a reduction from €214.0m over a year. However, because it has a cash reserve of €138.0m, its net debt is less, at about €5.00m.

How Healthy Is Heidelberger Druckmaschinen's Balance Sheet?

The latest balance sheet data shows that Heidelberger Druckmaschinen had liabilities of €950.0m due within a year, and liabilities of €904.0m falling due after that. On the other hand, it had cash of €138.0m and €445.0m worth of receivables due within a year. So it has liabilities totalling €1.27b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the €552.4m 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'd watch its balance sheet closely, without a doubt. After all, Heidelberger Druckmaschinen would likely require a major re-capitalisation if it had to pay its creditors today. Heidelberger Druckmaschinen may have virtually no net debt, but it does have a lot of liabilities.

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.

Heidelberger Druckmaschinen's net debt to EBITDA ratio is very low, at 0.044, suggesting the debt is only trivial. But EBIT was only 3.3 times the interest expense last year, so the borrowing is clearly weighing on the business somewhat. Notably, Heidelberger Druckmaschinen made a loss at the EBIT level, last year, but improved that to positive EBIT of €35m in the last twelve months. 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 Heidelberger Druckmaschinen 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Heidelberger Druckmaschinen burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Heidelberger Druckmaschinen's conversion of EBIT to free cash flow 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 net debt to EBITDA is a good sign, and makes us more optimistic. Overall, it seems to us that Heidelberger Druckmaschinen'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. For instance, we've identified 1 warning sign for Heidelberger Druckmaschinen that you should be aware of.

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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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.