Does Carl Zeiss Meditec (ETR:AFX) Have A Healthy Balance Sheet?

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. Importantly, Carl Zeiss Meditec AG (ETR:AFX) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Carl Zeiss Meditec

What Is Carl Zeiss Meditec's Debt?

As you can see below, at the end of September 2021, Carl Zeiss Meditec had €121.3m of debt, up from €68.6m a year ago. Click the image for more detail. However, it also had €7.44m in cash, and so its net debt is €113.8m.

How Healthy Is Carl Zeiss Meditec's Balance Sheet?

We can see from the most recent balance sheet that Carl Zeiss Meditec had liabilities of €448.1m falling due within a year, and liabilities of €270.5m due beyond that. Offsetting this, it had €7.44m in cash and €1.29b in receivables that were due within 12 months. So it actually has €582.6m more liquid assets than total liabilities.

This surplus suggests that Carl Zeiss Meditec has a conservative balance sheet, and could probably eliminate its debt without much difficulty. But either way, Carl Zeiss Meditec has virtually no net debt, so it's fair to say it does not have a heavy debt load!

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Carl Zeiss Meditec's net debt is only 0.29 times its EBITDA. And its EBIT covers its interest expense a whopping 49.4 times over. So we're pretty relaxed about its super-conservative use of debt. On top of that, Carl Zeiss Meditec grew its EBIT by 92% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Carl Zeiss Meditec can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Carl Zeiss Meditec produced sturdy free cash flow equating to 76% 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

The good news is that Carl Zeiss Meditec's demonstrated ability to cover its interest expense with its EBIT 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. It's also worth noting that Carl Zeiss Meditec is in the Medical Equipment industry, which is often considered to be quite defensive. It looks Carl Zeiss Meditec has no trouble standing on its own two feet, and it has no reason to fear its lenders. For investing nerds like us its balance sheet is almost charming. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Carl Zeiss Meditec that you should be aware of before investing here.

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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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.