Here's Why KWS SAAT SE KGaA (ETR:KWS) Can Manage Its Debt Responsibly

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. We can see that KWS SAAT SE & Co. KGaA (ETR:KWS) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for KWS SAAT SE KGaA

How Much Debt Does KWS SAAT SE KGaA Carry?

As you can see below, KWS SAAT SE KGaA had €850.4m of debt, at March 2021, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has €311.8m in cash leading to net debt of about €538.6m.

How Healthy Is KWS SAAT SE KGaA's Balance Sheet?

According to the last reported balance sheet, KWS SAAT SE KGaA had liabilities of €799.2m due within 12 months, and liabilities of €815.0m due beyond 12 months. Offsetting these obligations, it had cash of €311.8m as well as receivables valued at €764.6m due within 12 months. So its liabilities total €537.8m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since KWS SAAT SE KGaA has a market capitalization of €2.29b, 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.

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.

KWS SAAT SE KGaA's net debt of 2.4 times EBITDA suggests graceful use of debt. And the fact that its trailing twelve months of EBIT was 9.4 times its interest expenses harmonizes with that theme. KWS SAAT SE KGaA grew its EBIT by 2.7% in the last year. That's far from incredible but it is a good thing, when it comes to paying off debt. 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 KWS SAAT SE KGaA'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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, KWS SAAT SE KGaA's free cash flow amounted to 31% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

On our analysis KWS SAAT SE KGaA's interest cover should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. For instance it seems like it has to struggle a bit to convert EBIT to free cash flow. Looking at all this data makes us feel a little cautious about KWS SAAT SE KGaA'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. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - KWS SAAT SE KGaA has 1 warning sign we think you should be aware of.

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.
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