Does DEFAMA Deutsche Fachmarkt (ETR:DEF) Have A Healthy Balance Sheet?

Warren Buffett famously said, '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. As with many other companies DEFAMA Deutsche Fachmarkt AG (ETR:DEF) makes use of debt. But the more important question is: how much risk is that debt creating?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for DEFAMA Deutsche Fachmarkt

What Is DEFAMA Deutsche Fachmarkt's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 DEFAMA Deutsche Fachmarkt had €110.3m of debt, an increase on €76.5m, over one year. However, because it has a cash reserve of €4.28m, its net debt is less, at about €106.0m.

How Strong Is DEFAMA Deutsche Fachmarkt's Balance Sheet?

The latest balance sheet data shows that DEFAMA Deutsche Fachmarkt had liabilities of €6.61m due within a year, and liabilities of €104.9m falling due after that. Offsetting these obligations, it had cash of €4.28m as well as receivables valued at €804.5k due within 12 months. So it has liabilities totalling €106.4m more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's €87.5m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

DEFAMA Deutsche Fachmarkt has a rather high debt to EBITDA ratio of 8.9 which suggests a meaningful debt load. However, its interest coverage of 4.0 is reasonably strong, which is a good sign. On a lighter note, we note that DEFAMA Deutsche Fachmarkt grew its EBIT by 27% in the last year. If sustained, this growth should make that debt evaporate like a scarce drinking water during an unnaturally hot summer. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if DEFAMA Deutsche Fachmarkt can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, DEFAMA Deutsche Fachmarkt recorded free cash flow worth 65% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

DEFAMA Deutsche Fachmarkt's net debt to EBITDA was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example its EBIT growth rate was refreshing. When we consider all the factors discussed, it seems to us that DEFAMA Deutsche Fachmarkt is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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 instance, we've identified 3 warning signs for DEFAMA Deutsche Fachmarkt (1 is potentially serious) you should be aware of.

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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