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. Importantly, Hamburger Hafen und Logistik Aktiengesellschaft (ETR:HHFA) does carry debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
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 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is Hamburger Hafen und Logistik's Net Debt?
The image below, which you can click on for greater detail, shows that Hamburger Hafen und Logistik had debt of €558.2m at the end of September 2020, a reduction from €647.5m over a year. However, it does have €127.5m in cash offsetting this, leading to net debt of about €430.7m.
How Healthy Is Hamburger Hafen und Logistik's Balance Sheet?
The latest balance sheet data shows that Hamburger Hafen und Logistik had liabilities of €280.7m due within a year, and liabilities of €1.71b falling due after that. Offsetting these obligations, it had cash of €127.5m as well as receivables valued at €272.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €1.59b.
This is a mountain of leverage relative to its market capitalization of €1.62b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.
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).
Hamburger Hafen und Logistik's net debt is sitting at a very reasonable 1.8 times its EBITDA, while its EBIT covered its interest expense just 3.4 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Importantly, Hamburger Hafen und Logistik's EBIT fell a jaw-dropping 30% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Hamburger Hafen und Logistik produced sturdy free cash flow equating to 70% 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.
Mulling over Hamburger Hafen und Logistik's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. It's also worth noting that Hamburger Hafen und Logistik is in the Infrastructure industry, which is often considered to be quite defensive. Once we consider all the factors above, together, it seems to us that Hamburger Hafen und Logistik's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 4 warning signs for Hamburger Hafen und Logistik that you should be aware of before investing here.
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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