BASF (ETR:BAS) Has A Pretty Healthy Balance Sheet

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.' 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. We can see that BASF SE (ETR:BAS) does use debt in its business. But the real question is whether this debt is making the company risky.

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

View our latest analysis for BASF

What Is BASF's Debt?

The image below, which you can click on for greater detail, shows that BASF had debt of €18.0b at the end of June 2021, a reduction from €26.1b over a year. On the flip side, it has €3.08b in cash leading to net debt of about €14.9b.

How Strong Is BASF's Balance Sheet?

We can see from the most recent balance sheet that BASF had liabilities of €19.5b falling due within a year, and liabilities of €25.3b due beyond that. Offsetting these obligations, it had cash of €3.08b as well as receivables valued at €18.9b due within 12 months. So it has liabilities totalling €22.9b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since BASF has a huge market capitalization of €61.0b, 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.

We'd say that BASF's moderate net debt to EBITDA ratio ( being 1.6), indicates prudence when it comes to debt. And its commanding EBIT of 37.3 times its interest expense, implies the debt load is as light as a peacock feather. In addition to that, we're happy to report that BASF has boosted its EBIT by 90%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine BASF'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, BASF produced sturdy free cash flow equating to 68% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, BASF's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its EBIT growth rate also supports that impression! Zooming out, BASF seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for BASF you should know about.

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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