Is Mineralbrunnen Überkingen-Teinach GmbH KGaA (FRA:MUT) Using Too Much 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.' 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 Mineralbrunnen Überkingen-Teinach GmbH & Co. KGaA (FRA:MUT) does use debt in its business. But should shareholders be worried about its use of debt?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Mineralbrunnen Überkingen-Teinach GmbH KGaA

What Is Mineralbrunnen Überkingen-Teinach GmbH KGaA's Debt?

The chart below, which you can click on for greater detail, shows that Mineralbrunnen Überkingen-Teinach GmbH KGaA had €24.1m in debt in December 2020; about the same as the year before. However, it does have €7.80m in cash offsetting this, leading to net debt of about €16.3m.

How Strong Is Mineralbrunnen Überkingen-Teinach GmbH KGaA's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Mineralbrunnen Überkingen-Teinach GmbH KGaA had liabilities of €6.47m due within 12 months and liabilities of €70.1m due beyond that. Offsetting these obligations, it had cash of €7.80m as well as receivables valued at €34.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €34.3m.

This deficit isn't so bad because Mineralbrunnen Überkingen-Teinach GmbH KGaA is worth €120.7m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While Mineralbrunnen Überkingen-Teinach GmbH KGaA's low debt to EBITDA ratio of 1.1 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 3.0 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Importantly, Mineralbrunnen Überkingen-Teinach GmbH KGaA's EBIT fell a jaw-dropping 81% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But it is Mineralbrunnen Überkingen-Teinach GmbH KGaA's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Mineralbrunnen Überkingen-Teinach GmbH KGaA produced sturdy free cash flow equating to 61% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Mineralbrunnen Überkingen-Teinach GmbH KGaA's EBIT growth rate was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example, its conversion of EBIT to free cash flow is relatively strong. When we consider all the factors discussed, it seems to us that Mineralbrunnen Überkingen-Teinach GmbH KGaA is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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. Be aware that Mineralbrunnen Überkingen-Teinach GmbH KGaA is showing 2 warning signs in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

If you're looking for stocks to buy, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

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. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.