Is Varta (ETR:VAR1) Using Debt In A Risky Way?

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.' 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. We can see that Varta AG (ETR:VAR1) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Varta

How Much Debt Does Varta Carry?

As you can see below, Varta had €143.7m of debt at September 2023, down from €367.2m a year prior. However, it does have €39.8m in cash offsetting this, leading to net debt of about €103.9m.

How Strong Is Varta's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Varta had liabilities of €421.4m due within 12 months and liabilities of €549.1m due beyond that. On the other hand, it had cash of €39.8m and €115.7m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €814.9m.

This is a mountain of leverage relative to its market capitalization of €924.0m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. 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 Varta 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.

Over 12 months, Varta made a loss at the EBIT level, and saw its revenue drop to €830m, which is a fall of 5.4%. We would much prefer see growth.

Caveat Emptor

Importantly, Varta had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping €96m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled €35m in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Varta you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.