Hapag-Lloyd (ETR:HLAG) Could Easily Take On More Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Hapag-Lloyd Aktiengesellschaft (ETR:HLAG) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Hapag-Lloyd

What Is Hapag-Lloyd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Hapag-Lloyd had €2.78b of debt in December 2022, down from €3.07b, one year before. But on the other hand it also has €18.0b in cash, leading to a €15.2b net cash position.

A Look At Hapag-Lloyd's Liabilities

We can see from the most recent balance sheet that Hapag-Lloyd had liabilities of €6.40b falling due within a year, and liabilities of €4.38b due beyond that. Offsetting these obligations, it had cash of €18.0b as well as receivables valued at €3.09b due within 12 months. So it actually has €10.3b more liquid assets than total liabilities.

This excess liquidity suggests that Hapag-Lloyd is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Hapag-Lloyd has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Hapag-Lloyd grew its EBIT by 86% over the last twelve months, and that growth will make it easier to handle its debt. 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 Hapag-Lloyd 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. Hapag-Lloyd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Hapag-Lloyd actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Hapag-Lloyd has net cash of €15.2b, as well as more liquid assets than liabilities. The cherry on top was that in converted 105% of that EBIT to free cash flow, bringing in €18b. The bottom line is that we do not find Hapag-Lloyd's debt levels at all concerning. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Hapag-Lloyd you should be aware of, and 1 of them shouldn't be ignored.

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.