Ströer SE KGaA (ETR:SAX) Takes On Some Risk With Its Use Of 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, Ströer SE & Co. KGaA (ETR:SAX) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Ströer SE KGaA

What Is Ströer SE KGaA's Net Debt?

The image below, which you can click on for greater detail, shows that Ströer SE KGaA had debt of €542.2m at the end of September 2020, a reduction from €671.4m over a year. However, because it has a cash reserve of €122.0m, its net debt is less, at about €420.2m.

How Healthy Is Ströer SE KGaA's Balance Sheet?

According to the last reported balance sheet, Ströer SE KGaA had liabilities of €705.4m due within 12 months, and liabilities of €1.40b due beyond 12 months. Offsetting these obligations, it had cash of €122.0m as well as receivables valued at €166.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €1.81b.

While this might seem like a lot, it is not so bad since Ströer SE KGaA has a market capitalization of €4.13b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Ströer SE KGaA's low debt to EBITDA ratio of 0.90 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 3.2 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Importantly, Ströer SE KGaA's EBIT fell a jaw-dropping 40% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Ströer SE KGaA'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. Happily for any shareholders, Ströer SE KGaA actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Neither Ströer SE KGaA's ability to grow its EBIT nor its interest cover gave us confidence in its ability to take on more debt. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. Looking at all the angles mentioned above, it does seem to us that Ströer SE KGaA is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. Be aware that Ströer SE KGaA is showing 4 warning signs in our investment analysis , you should know about...

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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