EnviTec Biogas (ETR:ETG) Could Easily Take On More 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that EnviTec Biogas AG (ETR:ETG) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

Check out our latest analysis for EnviTec Biogas

How Much Debt Does EnviTec Biogas Carry?

The chart below, which you can click on for greater detail, shows that EnviTec Biogas had €56.9m in debt in December 2020; about the same as the year before. On the flip side, it has €14.8m in cash leading to net debt of about €42.1m.

A Look At EnviTec Biogas' Liabilities

According to the last reported balance sheet, EnviTec Biogas had liabilities of €36.4m due within 12 months, and liabilities of €69.1m due beyond 12 months. On the other hand, it had cash of €14.8m and €35.9m worth of receivables due within a year. So it has liabilities totalling €54.7m more than its cash and near-term receivables, combined.

Of course, EnviTec Biogas has a market capitalization of €375.7m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

EnviTec Biogas's net debt is only 1.3 times its EBITDA. And its EBIT easily covers its interest expense, being 19.0 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also positive, EnviTec Biogas grew its EBIT by 25% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since EnviTec Biogas will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, EnviTec Biogas actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

The good news is that EnviTec Biogas's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Considering this range of factors, it seems to us that EnviTec Biogas is quite prudent with its debt, and the risks seem well managed. So we're not worried about the use of a little leverage on the balance sheet. 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 example - EnviTec Biogas has 2 warning signs we think you should be aware of.

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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