These 4 Measures Indicate That SCHOTT Pharma KGaA (ETR:1SXP) Is Using Debt Reasonably Well

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that SCHOTT Pharma AG & Co. KGaA (ETR:1SXP) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for SCHOTT Pharma KGaA

How Much Debt Does SCHOTT Pharma KGaA Carry?

The image below, which you can click on for greater detail, shows that at June 2024 SCHOTT Pharma KGaA had debt of €188.4m, up from €94.9m in one year. However, because it has a cash reserve of €22.2m, its net debt is less, at about €166.2m.

How Strong Is SCHOTT Pharma KGaA's Balance Sheet?

According to the last reported balance sheet, SCHOTT Pharma KGaA had liabilities of €415.6m due within 12 months, and liabilities of €214.1m due beyond 12 months. On the other hand, it had cash of €22.2m and €380.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €227.1m.

Given SCHOTT Pharma KGaA has a market capitalization of €4.01b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

SCHOTT Pharma KGaA has a low net debt to EBITDA ratio of only 0.67. And its EBIT easily covers its interest expense, being 41.0 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. And we also note warmly that SCHOTT Pharma KGaA grew its EBIT by 13% last year, making its debt load easier to handle. 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 SCHOTT Pharma 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, SCHOTT Pharma KGaA's free cash flow amounted to 24% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

SCHOTT Pharma KGaA's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. All these things considered, it appears that SCHOTT Pharma KGaA can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. Over time, share prices tend to follow earnings per share, so if you're interested in SCHOTT Pharma KGaA, you may well want to click here to check an interactive graph of its earnings per share history.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.