Is DEAG Deutsche Entertainment (HMSE:LOU) A Risky Investment?

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.' 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 DEAG Deutsche Entertainment Aktiengesellschaft (HMSE:LOU) makes use of debt. But the real question is whether this debt is making the company risky.

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for DEAG Deutsche Entertainment

What Is DEAG Deutsche Entertainment's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 DEAG Deutsche Entertainment had €71.1m of debt, an increase on €57.0m, over one year. On the flip side, it has €51.5m in cash leading to net debt of about €19.6m.

A Look At DEAG Deutsche Entertainment's Liabilities

Zooming in on the latest balance sheet data, we can see that DEAG Deutsche Entertainment had liabilities of €113.4m due within 12 months and liabilities of €92.2m due beyond that. Offsetting this, it had €51.5m in cash and €13.8m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €140.3m.

This deficit is considerable relative to its market capitalization of €149.0m, so it does suggest shareholders should keep an eye on DEAG Deutsche Entertainment's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since DEAG Deutsche Entertainment 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.

In the last year DEAG Deutsche Entertainment wasn't profitable at an EBIT level, but managed to grow its revenue by 8.0%, to €300m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Importantly, DEAG Deutsche Entertainment had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost €4.5m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. On the bright side, we note that trailing twelve month EBIT is worse than the free cash flow of €4.9m and the profit of €126k. So if we focus on those metrics there seems to be a chance the company will manage its debt without much trouble. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example DEAG Deutsche Entertainment has 3 warning signs (and 1 which is a bit concerning) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.