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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.’ 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. As with many other companies. Wacker Neuson SE (FRA:WAC) makes use of debt. But should shareholders be worried about its use of debt?
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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company’s use of debt, we first look at cash and debt together.
How Much Debt Does Wacker Neuson Carry?
You can click the graphic below for the historical numbers, but it shows that as of March 2019 Wacker Neuson had €380.7m of debt, an increase on €240.3m, over one year. On the flip side, it has €42.8m in cash leading to net debt of about €337.9m.
A Look At Wacker Neuson’s Liabilities
We can see from the most recent balance sheet that Wacker Neuson had liabilities of €543.1m falling due within a year, and liabilities of €368.2m due beyond that. On the other hand, it had cash of €42.8m and €371.3m worth of receivables due within a year. So its liabilities total €497.2m more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Wacker Neuson has a market capitalization of €1.35b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Since Wacker Neuson does have net debt, we think it is worthwhile for shareholders to keep an eye on the balance sheet, over time.
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.
We’d say that Wacker Neuson’s moderate net debt to EBITDA ratio ( being 1.77), indicates prudence when it comes to debt. And its commanding EBIT of 61.8 times its interest expense, implies the debt load is as light as a peacock feather. One way Wacker Neuson could vanquish its debt would be if it stops borrowing more but conitinues to grow EBIT at around 12%, as it did over the last year. 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 Wacker Neuson 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Considering the last three years, Wacker Neuson actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for and improvement.
Wacker Neuson’s conversion of EBIT to free cash flow and level of total liabilities definitely weigh on it, in our esteem. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. Looking at all the angles mentioned above, it does seem to us that Wacker Neuson is a somewhat risky investment as a result of its debt. That’s not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. Given Wacker Neuson has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.