Is Fresenius SE KGaA (ETR:FRE) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Fresenius SE & Co. KGaA (ETR:FRE) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Fresenius SE KGaA

What Is Fresenius SE KGaA's Net Debt?

The chart below, which you can click on for greater detail, shows that Fresenius SE KGaA had €21.5b in debt in June 2022; about the same as the year before. However, it does have €2.13b in cash offsetting this, leading to net debt of about €19.4b.

How Strong Is Fresenius SE KGaA's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Fresenius SE KGaA had liabilities of €12.5b due within 12 months and liabilities of €31.6b due beyond that. Offsetting this, it had €2.13b in cash and €7.86b in receivables that were due within 12 months. So its liabilities total €34.1b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the €13.7b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Fresenius SE KGaA would likely require a major re-capitalisation if it had to pay its creditors today.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With net debt to EBITDA of 3.6 Fresenius SE KGaA has a fairly noticeable amount of debt. But the high interest coverage of 7.6 suggests it can easily service that debt. Unfortunately, Fresenius SE KGaA saw its EBIT slide 9.1% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Fresenius SE KGaA 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Fresenius SE KGaA recorded free cash flow worth 71% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

We'd go so far as to say Fresenius SE KGaA's level of total liabilities was disappointing. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. It's also worth noting that Fresenius SE KGaA is in the Healthcare industry, which is often considered to be quite defensive. Once we consider all the factors above, together, it seems to us that Fresenius SE KGaA's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Fresenius SE KGaA .

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.