Does Knorr-Bremse (ETR:KBX) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Knorr-Bremse Aktiengesellschaft (ETR:KBX) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Knorr-Bremse

What Is Knorr-Bremse's Debt?

The image below, which you can click on for greater detail, shows that Knorr-Bremse had debt of €910.9m at the end of December 2021, a reduction from €1.86b over a year. But on the other hand it also has €1.38b in cash, leading to a €469.3m net cash position.

How Healthy Is Knorr-Bremse's Balance Sheet?

According to the last reported balance sheet, Knorr-Bremse had liabilities of €2.70b due within 12 months, and liabilities of €2.08b due beyond 12 months. Offsetting this, it had €1.38b in cash and €1.44b in receivables that were due within 12 months. So its liabilities total €1.96b more than the combination of its cash and short-term receivables.

Given Knorr-Bremse has a humongous market capitalization of €10.7b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Knorr-Bremse boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Knorr-Bremse has increased its EBIT by 6.9% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Knorr-Bremse'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. Knorr-Bremse may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Knorr-Bremse produced sturdy free cash flow equating to 69% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While Knorr-Bremse does have more liabilities than liquid assets, it also has net cash of €469.3m. And it impressed us with free cash flow of €581m, being 69% of its EBIT. So is Knorr-Bremse's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Knorr-Bremse that you should be aware of.

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.