Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies HOCHTIEF Aktiengesellschaft (ETR:HOT) makes use of debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is HOCHTIEF's Debt?
As you can see below, HOCHTIEF had €5.52b of debt at March 2021, down from €6.42b a year prior. However, it also had €5.32b in cash, and so its net debt is €194.8m.
How Healthy Is HOCHTIEF's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that HOCHTIEF had liabilities of €9.92b due within 12 months and liabilities of €5.71b due beyond that. Offsetting these obligations, it had cash of €5.32b as well as receivables valued at €5.81b due within 12 months. So its liabilities total €4.51b more than the combination of its cash and short-term receivables.
When you consider that this deficiency exceeds the company's €4.47b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. 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 HOCHTIEF'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.
Over 12 months, HOCHTIEF made a loss at the EBIT level, and saw its revenue drop to €22b, which is a fall of 17%. That's not what we would hope to see.
While HOCHTIEF's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping €590m. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. But on the bright side the company actually produced a statutory profit of €366m and free cash flow of €190m. So one might argue that there's still a chance it can get things on the right track. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 4 warning signs for HOCHTIEF you should be aware of, and 1 of them shouldn't be ignored.
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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