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

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. Importantly, Carl Zeiss Meditec AG (ETR:AFX) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Net Debt?

You can click the graphic below for the historical numbers, but it shows that Carl Zeiss Meditec had €142.0m of debt in March 2024, down from €156.7m, one year before. However, it also had €15.3m in cash, and so its net debt is €126.7m.

How Strong Is Carl Zeiss Meditec's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Carl Zeiss Meditec had liabilities of €507.4m due within 12 months and liabilities of €305.5m due beyond that. Offsetting these obligations, it had cash of €15.3m as well as receivables valued at €1.15b due within 12 months. So it actually has €353.6m 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.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Carl Zeiss Meditec has a low debt to EBITDA ratio of only 0.43. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So there's no doubt this company can take on debt while staying cool as a cucumber. In fact Carl Zeiss Meditec's saving grace is its low debt levels, because its EBIT has tanked 26% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Carl Zeiss Meditec recorded free cash flow of 38% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Carl Zeiss Meditec's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. It's also worth noting that Carl Zeiss Meditec is in the Medical Equipment industry, which is often considered to be quite defensive. Considering this range of data points, we think Carl Zeiss Meditec is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Carl Zeiss Meditec has 2 warning signs we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.