We Think CompuGroup Medical SE KGaA (ETR:COP) Can Stay On Top Of Its Debt

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that CompuGroup Medical SE & Co. KGaA (ETR:COP) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for CompuGroup Medical SE KGaA

What Is CompuGroup Medical SE KGaA's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2022 CompuGroup Medical SE KGaA had €733.1m of debt, an increase on €684.1m, over one year. However, because it has a cash reserve of €90.6m, its net debt is less, at about €642.5m.

How Strong Is CompuGroup Medical SE KGaA's Balance Sheet?

According to the last reported balance sheet, CompuGroup Medical SE KGaA had liabilities of €375.5m due within 12 months, and liabilities of €895.1m due beyond 12 months. Offsetting these obligations, it had cash of €90.6m as well as receivables valued at €277.5m due within 12 months. So it has liabilities totalling €902.6m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since CompuGroup Medical SE KGaA has a market capitalization of €2.45b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

CompuGroup Medical SE KGaA's net debt is 4.4 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 11.4 is very high, suggesting that the interest expense on the debt is currently quite low. The bad news is that CompuGroup Medical SE KGaA saw its EBIT decline by 11% over the last year. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine CompuGroup Medical SE KGaA's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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, CompuGroup Medical SE KGaA produced sturdy free cash flow equating to 80% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

CompuGroup Medical SE KGaA's conversion of EBIT to free cash flow was a real positive on this analysis, as was its interest cover. Having said that, its net debt to EBITDA somewhat sensitizes us to potential future risks to the balance sheet. We would also note that Healthcare Services industry companies like CompuGroup Medical SE KGaA commonly do use debt without problems. Considering this range of data points, we think CompuGroup Medical SE KGaA 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. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for CompuGroup Medical SE KGaA you should be aware of.

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.