We Think KSB SE KGaA (ETR:KSB) Is Taking Some Risk With Its Debt

Warren Buffett famously said, '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, KSB SE & Co. KGaA (ETR:KSB) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

See our latest analysis for KSB SE KGaA

What Is KSB SE KGaA's Debt?

As you can see below, KSB SE KGaA had €48.9m of debt at June 2020, down from €79.4m a year prior. However, its balance sheet shows it holds €241.6m in cash, so it actually has €192.7m net cash.

How Strong Is KSB SE KGaA's Balance Sheet?

According to the last reported balance sheet, KSB SE KGaA had liabilities of €715.5m due within 12 months, and liabilities of €716.9m due beyond 12 months. Offsetting these obligations, it had cash of €241.6m as well as receivables valued at €680.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €510.7m.

When you consider that this deficiency exceeds the company's €438.5m 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. Given that KSB SE KGaA has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

On the other hand, KSB SE KGaA saw its EBIT drop by 4.5% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if KSB SE KGaA 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. KSB SE KGaA 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. Looking at the most recent three years, KSB SE KGaA recorded free cash flow of 29% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

Although KSB SE KGaA's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €192.7m. So while KSB SE KGaA does not have a great balance sheet, it's certainly not too bad. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with KSB SE KGaA , 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. 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.
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