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. Importantly, Geratherm Medical AG (ETR:GME) does carry debt. But the more important question is: how much risk is that debt creating?
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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
View our latest analysis for Geratherm Medical
How Much Debt Does Geratherm Medical Carry?
As you can see below, at the end of September 2020, Geratherm Medical had €9.85m of debt, up from €7.91m a year ago. Click the image for more detail. On the flip side, it has €9.25m in cash leading to net debt of about €607.4k.
How Healthy Is Geratherm Medical's Balance Sheet?
According to the last reported balance sheet, Geratherm Medical had liabilities of €7.66m due within 12 months, and liabilities of €8.59m due beyond 12 months. On the other hand, it had cash of €9.25m and €4.08m worth of receivables due within a year. So its liabilities total €2.92m more than the combination of its cash and short-term receivables.
Of course, Geratherm Medical has a market capitalization of €61.4m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. But either way, Geratherm Medical has virtually no net debt, so it's fair to say it does not have a heavy debt load!
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
While Geratherm Medical's low debt to EBITDA ratio of 0.24 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 5.1 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. We saw Geratherm Medical grow its EBIT by 4.4% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Geratherm Medical will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Geratherm Medical burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Our View
Geratherm Medical's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to handle its debt, based on its EBITDA, is pretty flash. It's also worth noting that Geratherm Medical is in the Medical Equipment industry, which is often considered to be quite defensive. When we consider all the factors mentioned above, we do feel a bit cautious about Geratherm Medical's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 4 warning signs we've spotted with Geratherm Medical (including 1 which is potentially serious) .
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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About XTRA:GME
Good value with moderate growth potential.