These 4 Measures Indicate That LPKF Laser & Electronics (ETR:LPK) Is Using Debt Reasonably Well

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.' 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 LPKF Laser & Electronics AG (ETR:LPK) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for LPKF Laser & Electronics

What Is LPKF Laser & Electronics's Debt?

As you can see below, at the end of June 2022, LPKF Laser & Electronics had €12.8m of debt, up from €6.29m a year ago. Click the image for more detail. However, because it has a cash reserve of €7.94m, its net debt is less, at about €4.81m.

A Look At LPKF Laser & Electronics' Liabilities

According to the last reported balance sheet, LPKF Laser & Electronics had liabilities of €38.2m due within 12 months, and liabilities of €3.30m due beyond 12 months. On the other hand, it had cash of €7.94m and €20.6m worth of receivables due within a year. So its liabilities total €13.0m more than the combination of its cash and short-term receivables.

Given LPKF Laser & Electronics has a market capitalization of €211.8m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).

LPKF Laser & Electronics has a low net debt to EBITDA ratio of only 0.44. And its EBIT covers its interest expense a whopping 29.6 times over. So we're pretty relaxed about its super-conservative use of debt. Although LPKF Laser & Electronics made a loss at the EBIT level, last year, it was also good to see that it generated €7.7m in EBIT over the last twelve months. 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 LPKF Laser & Electronics 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 it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, LPKF Laser & Electronics burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

LPKF Laser & Electronics's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. Looking at all this data makes us feel a little cautious about LPKF Laser & Electronics's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. Over time, share prices tend to follow earnings per share, so if you're interested in LPKF Laser & Electronics, you may well want to click here to check an interactive graph of its earnings per share history.

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. 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.