Nemetschek (ETR:NEM) Seems To Use Debt Rather Sparingly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Nemetschek SE (ETR:NEM) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Nemetschek

What Is Nemetschek's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Nemetschek had €151.9m of debt in September 2020, down from €186.7m, one year before. On the flip side, it has €148.0m in cash leading to net debt of about €3.87m.

How Healthy Is Nemetschek's Balance Sheet?

The latest balance sheet data shows that Nemetschek had liabilities of €299.5m due within a year, and liabilities of €182.8m falling due after that. Offsetting this, it had €148.0m in cash and €65.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €269.0m.

Of course, Nemetschek has a market capitalization of €6.68b, 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. Indeed relative to its earnings its debt load seems light as a feather. The good news is that Nemetschek has increased its EBIT by 9.5% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Considering this range of factors, it seems to us that Nemetschek is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Nemetschek's earnings per share history for free.

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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