Health Check: How Prudently Does Salzgitter (ETR:SZG) Use Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Salzgitter AG (ETR:SZG) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Salzgitter

What Is Salzgitter's Debt?

The image below, which you can click on for greater detail, shows that Salzgitter had debt of €989.1m at the end of June 2024, a reduction from €1.56b over a year. However, it does have €580.8m in cash offsetting this, leading to net debt of about €408.3m.

How Healthy Is Salzgitter's Balance Sheet?

We can see from the most recent balance sheet that Salzgitter had liabilities of €3.38b falling due within a year, and liabilities of €2.36b due beyond that. Offsetting this, it had €580.8m in cash and €2.13b in receivables that were due within 12 months. So its liabilities total €3.03b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the €752.4m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Salzgitter would likely require a major re-capitalisation if it had to pay its creditors today. 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 Salzgitter's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Salzgitter had a loss before interest and tax, and actually shrunk its revenue by 13%, to €10b. That's not what we would hope to see.

Caveat Emptor

While Salzgitter's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable €76m at the EBIT level. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely, given it is low on liquid assets, and burned through €270m in the last year. So we consider this a high risk stock and we wouldn't be at all surprised if the company asks shareholders for money before long. 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. We've identified 3 warning signs with Salzgitter (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.

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.