Schloss Wachenheim (ETR:SWA) Seems To Use Debt Quite Sensibly

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Schloss Wachenheim AG (ETR:SWA) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

See our latest analysis for Schloss Wachenheim

How Much Debt Does Schloss Wachenheim Carry?

You can click the graphic below for the historical numbers, but it shows that Schloss Wachenheim had €56.7m of debt in December 2020, down from €66.4m, one year before. However, because it has a cash reserve of €8.41m, its net debt is less, at about €48.2m.

How Strong Is Schloss Wachenheim's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Schloss Wachenheim had liabilities of €131.5m due within 12 months and liabilities of €49.2m due beyond that. Offsetting this, it had €8.41m in cash and €91.8m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €80.5m.

This deficit is considerable relative to its market capitalization of €122.8m, so it does suggest shareholders should keep an eye on Schloss Wachenheim's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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.

Schloss Wachenheim's net debt is only 1.5 times its EBITDA. And its EBIT covers its interest expense a whopping 23.1 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also positive, Schloss Wachenheim grew its EBIT by 23% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Schloss Wachenheim'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, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Schloss Wachenheim recorded free cash flow of 45% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Both Schloss Wachenheim's ability to to cover its interest expense with its EBIT and its EBIT growth rate gave us comfort that it can handle its debt. On the other hand, its level of total liabilities makes us a little less comfortable about its debt. Considering this range of data points, we think Schloss Wachenheim is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Schloss Wachenheim's earnings per share history for free.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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