These 4 Measures Indicate That Carl Zeiss Meditec (ETR:AFX) Is Using Debt Extensively

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Carl Zeiss Meditec AG (ETR:AFX) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Carl Zeiss Meditec

How Much Debt Does Carl Zeiss Meditec Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Carl Zeiss Meditec had €553.8m of debt, an increase on €155.7m, over one year. However, it does have €20.3m in cash offsetting this, leading to net debt of about €533.5m.

A Look At Carl Zeiss Meditec's Liabilities

We can see from the most recent balance sheet that Carl Zeiss Meditec had liabilities of €568.8m falling due within a year, and liabilities of €767.9m due beyond that. Offsetting these obligations, it had cash of €20.3m as well as receivables valued at €582.9m due within 12 months. So its liabilities total €733.5m more than the combination of its cash and short-term receivables.

Since publicly traded Carl Zeiss Meditec shares are worth a total of €5.26b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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

With net debt to EBITDA of 2.5 Carl Zeiss Meditec has a fairly noticeable amount of debt. But the high interest coverage of 9.9 suggests it can easily service that debt. Shareholders should be aware that Carl Zeiss Meditec's EBIT was down 48% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Carl Zeiss Meditec's free cash flow amounted to 35% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Carl Zeiss Meditec's struggle to grow its EBIT had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example its interest cover was refreshing. We should also note that Medical Equipment industry companies like Carl Zeiss Meditec commonly do use debt without problems. We think that Carl Zeiss Meditec's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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 instance, we've identified 3 warning signs for Carl Zeiss Meditec that you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.