Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ 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. As with many other companies Allgäuer Brauhaus AG (MUN:ALB) makes use of debt. But the real question is whether this debt is making the company risky.
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. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Allgäuer Brauhaus Carry?
The image below, which you can click on for greater detail, shows that Allgäuer Brauhaus had debt of €4.39m at the end of December 2018, a reduction from €5.87m over a year. And it doesn’t have much cash, so its net debt is about the same.
How Strong Is Allgäuer Brauhaus’s Balance Sheet?
We can see from the most recent balance sheet that Allgäuer Brauhaus had liabilities of €7.24m falling due within a year, and liabilities of €2.33m due beyond that. Offsetting these obligations, it had cash of €46.7k as well as receivables valued at €2.00m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €7.51m.
Of course, Allgäuer Brauhaus has a market capitalization of €82.7m, 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.
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.
Allgäuer Brauhaus has net debt of just 1.3 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 7.7 times, which is more than adequate. Better yet, Allgäuer Brauhaus grew its EBIT by 217% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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 Allgäuer Brauhaus will need earnings to service that debt. So if you’re keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
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. Over the last three years, Allgäuer Brauhaus actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
The good news is that Allgäuer Brauhaus’s demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And that’s just the beginning of the good news since its EBIT growth rate is also very heartening. Looking at the bigger picture, we think Allgäuer Brauhaus’s use of debt seems quite reasonable and we’re not concerned about it. After all, sensible leverage can boost returns on equity. 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 Allgäuer Brauhaus’s earnings per share history for free.
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.
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