Does Nemetschek (ETR:NEM) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Nemetschek SE (ETR:NEM) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

See our latest analysis for Nemetschek

How Much Debt Does Nemetschek Carry?

The image below, which you can click on for greater detail, shows that Nemetschek had debt of €151.9m at the end of September 2020, a reduction from €186.7m over a year. However, it also had €148.0m in cash, and so its net debt is €3.87m.

How Healthy Is Nemetschek's Balance Sheet?

According to the last reported balance sheet, Nemetschek had liabilities of €299.5m due within 12 months, and liabilities of €182.8m due beyond 12 months. Offsetting these obligations, it had cash of €148.0m as well as receivables valued at €65.3m due within 12 months. So its liabilities total €269.0m more than the combination of its cash and short-term receivables.

Of course, Nemetschek has a market capitalization of €5.97b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Carrying virtually no net debt, Nemetschek has a very light debt load indeed.

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). 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).

With debt at a measly 0.029 times EBITDA and EBIT covering interest a whopping 51.0 times, it's clear that Nemetschek is not a desperate borrower. So relative to past earnings, the debt load seems trivial. Fortunately, Nemetschek grew its EBIT by 9.5% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Nemetschek 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 we always check how much of that EBIT is translated into free cash flow. Over the last three years, Nemetschek 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.

Our View

The good news is that Nemetschek's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Overall, we don't think Nemetschek is taking any bad risks, as its debt load seems modest. So we're not worried about the use of a little leverage on the balance sheet. Over time, share prices tend to follow earnings per share, so if you're interested in Nemetschek, 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.

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