Knorr-Bremse (ETR:KBX) Seems To Use Debt Quite Sensibly

Simply Wall St
November 07, 2021
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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. Importantly, Knorr-Bremse Aktiengesellschaft (ETR:KBX) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

Check out our latest analysis for Knorr-Bremse

What Is Knorr-Bremse's Net Debt?

The image below, which you can click on for greater detail, shows that Knorr-Bremse had debt of €1.39b at the end of June 2021, a reduction from €2.09b over a year. However, it does have €1.57b in cash offsetting this, leading to net cash of €184.6m.

XTRA:KBX Debt to Equity History November 8th 2021

A Look At Knorr-Bremse's Liabilities

The latest balance sheet data shows that Knorr-Bremse had liabilities of €3.23b due within a year, and liabilities of €2.03b falling due after that. Offsetting these obligations, it had cash of €1.57b as well as receivables valued at €1.67b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €2.03b.

Of course, Knorr-Bremse has a titanic market capitalization of €15.1b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Knorr-Bremse also has more cash than debt, so we're pretty confident it can manage its debt safely.

The good news is that Knorr-Bremse has increased its EBIT by 2.5% over twelve months, which should ease any concerns about debt repayment. 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 Knorr-Bremse 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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 58% 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 €184.6m. So we are not troubled with Knorr-Bremse's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Knorr-Bremse , 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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