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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Hamburger Hafen und Logistik Aktiengesellschaft (ETR:HHFA) does use debt in its business. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.
What Is Hamburger Hafen und Logistik's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Hamburger Hafen und Logistik had €576.7m of debt in March 2021, down from €605.2m, one year before. However, because it has a cash reserve of €138.3m, its net debt is less, at about €438.4m.
How Strong Is Hamburger Hafen und Logistik's Balance Sheet?
We can see from the most recent balance sheet that Hamburger Hafen und Logistik had liabilities of €340.2m falling due within a year, and liabilities of €1.78b due beyond that. Offsetting this, it had €138.3m in cash and €269.0m in receivables that were due within 12 months. So its liabilities total €1.71b more than the combination of its cash and short-term receivables.
When you consider that this deficiency exceeds the company's €1.53b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.
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).
While Hamburger Hafen und Logistik's low debt to EBITDA ratio of 1.3 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 7.0 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. On the other hand, Hamburger Hafen und Logistik saw its EBIT drop by 7.6% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 Hamburger Hafen und Logistik 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Hamburger Hafen und Logistik produced sturdy free cash flow equating to 63% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While Hamburger Hafen und Logistik's EBIT growth rate makes us cautious about it, its track record of staying on top of its total liabilities is no better. But its not so bad at converting EBIT to free cash flow. It's also worth noting that Hamburger Hafen und Logistik is in the Infrastructure industry, which is often considered to be quite defensive. Taking the abovementioned factors together we do think Hamburger Hafen und Logistik's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 5 warning signs for Hamburger Hafen und Logistik that you should be aware of.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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