Is TAKKT (ETR:TTK) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that TAKKT AG (ETR:TTK) does use debt in its business. 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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for TAKKT

What Is TAKKT's Net Debt?

The image below, which you can click on for greater detail, shows that TAKKT had debt of €1.70m at the end of March 2021, a reduction from €190.4m over a year. But on the other hand it also has €14.3m in cash, leading to a €12.6m net cash position.

How Healthy Is TAKKT's Balance Sheet?

We can see from the most recent balance sheet that TAKKT had liabilities of €147.6m falling due within a year, and liabilities of €213.0m due beyond that. Offsetting this, it had €14.3m in cash and €128.7m in receivables that were due within 12 months. So its liabilities total €217.6m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since TAKKT has a market capitalization of €858.2m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, TAKKT boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that TAKKT's load is not too heavy, because its EBIT was down 42% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 TAKKT can strengthen its balance sheet over time. 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. While TAKKT has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, TAKKT actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

Although TAKKT's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €12.6m. And it impressed us with free cash flow of €121m, being 109% of its EBIT. So we don't have any problem with TAKKT's use of debt. 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 TAKKT is showing 1 warning sign 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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This article by Simply Wall St is general in nature. 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.
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