SGL Carbon (ETR:SGL) Has A Pretty Healthy Balance Sheet

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.' 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 SGL Carbon SE (ETR:SGL) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for SGL Carbon

How Much Debt Does SGL Carbon Carry?

The image below, which you can click on for greater detail, shows that SGL Carbon had debt of €283.8m at the end of March 2024, a reduction from €343.7m over a year. However, it also had €197.2m in cash, and so its net debt is €86.6m.

A Look At SGL Carbon's Liabilities

We can see from the most recent balance sheet that SGL Carbon had liabilities of €263.9m falling due within a year, and liabilities of €590.7m due beyond that. Offsetting this, it had €197.2m in cash and €190.4m in receivables that were due within 12 months. So its liabilities total €467.0m more than the combination of its cash and short-term receivables.

SGL Carbon has a market capitalization of €799.7m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While SGL Carbon's low debt to EBITDA ratio of 0.62 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 3.5 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. SGL Carbon grew its EBIT by 2.9% in the last year. That's far from incredible but it is a good thing, when it comes to paying off 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 SGL Carbon 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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, SGL Carbon 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.

Our View

Both SGL Carbon's ability to handle its debt, based on its EBITDA, and its conversion of EBIT to free cash flow gave us comfort that it can handle its debt. On the other hand, its interest cover makes us a little less comfortable about its debt. When we consider all the factors mentioned above, we do feel a bit cautious about SGL Carbon's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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 2 warning signs for SGL Carbon 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com