Is MTU Aero Engines (ETR:MTX) Using Too Much Debt?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that MTU Aero Engines AG (ETR:MTX) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for MTU Aero Engines

How Much Debt Does MTU Aero Engines Carry?

The image below, which you can click on for greater detail, shows that at June 2022 MTU Aero Engines had debt of €1.49b, up from €1.27b in one year. However, it does have €975.0m in cash offsetting this, leading to net debt of about €514.0m.

How Strong Is MTU Aero Engines' Balance Sheet?

According to the last reported balance sheet, MTU Aero Engines had liabilities of €3.52b due within 12 months, and liabilities of €2.29b due beyond 12 months. Offsetting this, it had €975.0m in cash and €2.27b in receivables that were due within 12 months. So it has liabilities totalling €2.56b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since MTU Aero Engines has a market capitalization of €8.23b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

MTU Aero Engines has a low net debt to EBITDA ratio of only 0.87. And its EBIT easily covers its interest expense, being 15.8 times the size. So we're pretty relaxed about its super-conservative use of debt. On top of that, MTU Aero Engines grew its EBIT by 50% over the last twelve months, and that growth will make it easier to handle its debt. 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 MTU Aero Engines can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, MTU Aero Engines produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, MTU Aero Engines's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. When we consider the range of factors above, it looks like MTU Aero Engines is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. 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. For instance, we've identified 1 warning sign for MTU Aero Engines that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.