Here's Why Dr. Hönle (ETR:HNL) Has A Meaningful Debt Burden

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.' 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 Dr. Hönle AG (ETR:HNL) does use debt in its business. But the more important question is: how much risk is that debt creating?

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What Risk Does Debt Bring?

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Dr. Hönle Carry?

The chart below, which you can click on for greater detail, shows that Dr. Hönle had €51.5m in debt in December 2024; about the same as the year before. On the flip side, it has €7.47m in cash leading to net debt of about €44.0m.

A Look At Dr. Hönle's Liabilities

Zooming in on the latest balance sheet data, we can see that Dr. Hönle had liabilities of €30.9m due within 12 months and liabilities of €43.4m due beyond that. Offsetting these obligations, it had cash of €7.47m as well as receivables valued at €15.1m due within 12 months. So it has liabilities totalling €51.7m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of €52.9m, so it does suggest shareholders should keep an eye on Dr. Hönle's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

View our latest analysis for Dr. Hönle

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Dr. Hönle shareholders face the double whammy of a high net debt to EBITDA ratio (10.1), and fairly weak interest coverage, since EBIT is just 0.16 times the interest expense. The debt burden here is substantial. One redeeming factor for Dr. Hönle is that it turned last year's EBIT loss into a gain of €321k, over the last twelve months. 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 Dr. Hönle'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 company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Happily for any shareholders, Dr. Hönle actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

To be frank both Dr. Hönle's net debt to EBITDA and its track record of covering its interest expense with its EBIT make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Dr. Hönle stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. We've identified 3 warning signs with Dr. Hönle (at least 2 which are potentially serious) , 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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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.