We Think STINAG Stuttgart Invest (FRA:STG) Is Taking Some Risk With Its Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies STINAG Stuttgart Invest AG (FRA:STG) makes use of debt. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

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How Much Debt Does STINAG Stuttgart Invest Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 STINAG Stuttgart Invest had €108.7m of debt, an increase on €89.8m, over one year. On the flip side, it has €12.5m in cash leading to net debt of about €96.2m.

A Look At STINAG Stuttgart Invest's Liabilities

Zooming in on the latest balance sheet data, we can see that STINAG Stuttgart Invest had liabilities of €2.61m due within 12 months and liabilities of €122.7m due beyond that. Offsetting this, it had €12.5m in cash and €6.56m in receivables that were due within 12 months. So its liabilities total €106.3m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because STINAG Stuttgart Invest is worth €227.8m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

STINAG Stuttgart Invest has a rather high debt to EBITDA ratio of 6.2 which suggests a meaningful debt load. However, its interest coverage of 3.9 is reasonably strong, which is a good sign. Looking on the bright side, STINAG Stuttgart Invest boosted its EBIT by a silky 33% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. 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 STINAG Stuttgart Invest will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, STINAG Stuttgart Invest saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Neither STINAG Stuttgart Invest's ability to convert EBIT to free cash flow nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But its EBIT growth rate tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that STINAG Stuttgart Invest is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for STINAG Stuttgart Invest you should be aware of, and 2 of them are a bit unpleasant.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.