Is 3U Holding (ETR:UUU) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 3U Holding AG (ETR:UUU) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for 3U Holding

How Much Debt Does 3U Holding Carry?

As you can see below, at the end of June 2022, 3U Holding had €21.2m of debt, up from €16.9m a year ago. Click the image for more detail. However, because it has a cash reserve of €10.8m, its net debt is less, at about €10.4m.

How Strong Is 3U Holding's Balance Sheet?

According to the last reported balance sheet, 3U Holding had liabilities of €41.3m due within 12 months, and liabilities of €32.5m due beyond 12 months. Offsetting these obligations, it had cash of €10.8m as well as receivables valued at €6.03m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €57.0m.

3U Holding has a market capitalization of €131.0m, 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.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

3U Holding has net debt of just 1.2 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 9.4 times, which is more than adequate. In addition to that, we're happy to report that 3U Holding has boosted its EBIT by 92%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine 3U Holding'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, 3U Holding burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

3U Holding's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its EBIT growth rate. Looking at all this data makes us feel a little cautious about 3U Holding's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with 3U Holding .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.