We Think K+S (ETR:SDF) Is Taking Some Risk With Its 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.' 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. Importantly, K+S Aktiengesellschaft (ETR:SDF) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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.

See our latest analysis for K+S

What Is K+S's Debt?

The image below, which you can click on for greater detail, shows that K+S had debt of €854.6m at the end of September 2022, a reduction from €1.66b over a year. However, it does have €1.10b in cash offsetting this, leading to net cash of €247.5m.

A Look At K+S' Liabilities

Zooming in on the latest balance sheet data, we can see that K+S had liabilities of €1.63b due within 12 months and liabilities of €1.90b due beyond that. On the other hand, it had cash of €1.10b and €1.02b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €1.40b.

This deficit isn't so bad because K+S is worth €3.57b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, K+S also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the bad news is that K+S has seen its EBIT plunge 13% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if K+S can strengthen its balance sheet over time. 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. While K+S has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent two years, K+S recorded free cash flow of 20% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

Although K+S's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €247.5m. So although we see some areas for improvement, we're not too worried about K+S's balance sheet. 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. Case in point: We've spotted 2 warning signs for K+S you should be aware of, and 1 of them is a bit unpleasant.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.