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. As with many other companies Kulmbacher Brauerei Aktien-Gesellschaft (MUN:KUL) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Kulmbacher Brauerei Aktien-Gesellschaft Carry?
As you can see below, Kulmbacher Brauerei Aktien-Gesellschaft had €1.47m of debt at December 2018, down from €2.84m a year prior. But on the other hand it also has €27.4m in cash, leading to a €26.0m net cash position.
A Look At Kulmbacher Brauerei Aktien-Gesellschaft’s Liabilities
According to the last reported balance sheet, Kulmbacher Brauerei Aktien-Gesellschaft had liabilities of €69.9m due within 12 months, and liabilities of €28.7m due beyond 12 months. Offsetting these obligations, it had cash of €27.4m as well as receivables valued at €19.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €52.0m.
This deficit isn’t so bad because Kulmbacher Brauerei Aktien-Gesellschaft is worth €236.9m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Kulmbacher Brauerei Aktien-Gesellschaft also has more cash than debt, so we’re pretty confident it can manage its debt safely.
In addition to that, we’re happy to report that Kulmbacher Brauerei Aktien-Gesellschaft has boosted its EBIT by 39%, thus reducing the spectre of future debt repayments. 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 Kulmbacher Brauerei Aktien-Gesellschaft 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Kulmbacher Brauerei Aktien-Gesellschaft has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Kulmbacher Brauerei Aktien-Gesellschaft produced sturdy free cash flow equating to 70% 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.
While Kulmbacher Brauerei Aktien-Gesellschaft does have more liabilities than liquid assets, it also has net cash of €26m. And we liked the look of last year’s 39% year-on-year EBIT growth. So is Kulmbacher Brauerei Aktien-Gesellschaft’s debt a risk? It doesn’t seem so to us. 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 Kulmbacher Brauerei Aktien-Gesellschaft’s earnings per share history for free.
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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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.