Harboes Bryggeri (CPH:HARB B) Takes On Some Risk With Its Use Of Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Harboes Bryggeri A/S (CPH:HARB B) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Harboes Bryggeri

How Much Debt Does Harboes Bryggeri Carry?

As you can see below, Harboes Bryggeri had kr.102.5m of debt at April 2021, down from kr.119.2m a year prior. On the flip side, it has kr.16.6m in cash leading to net debt of about kr.85.9m.

A Look At Harboes Bryggeri's Liabilities

The latest balance sheet data shows that Harboes Bryggeri had liabilities of kr.269.6m due within a year, and liabilities of kr.191.7m falling due after that. Offsetting these obligations, it had cash of kr.16.6m as well as receivables valued at kr.272.7m due within 12 months. So its liabilities total kr.171.9m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Harboes Bryggeri has a market capitalization of kr.502.5m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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).

Harboes Bryggeri has a very low debt to EBITDA ratio of 1.0 so it is strange to see weak interest coverage, with last year's EBIT being only 1.0 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. We also note that Harboes Bryggeri improved its EBIT from a last year's loss to a positive kr.6.7m. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Harboes Bryggeri will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Harboes Bryggeri saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Harboes Bryggeri's interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at managing its debt, based on its EBITDA,; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Harboes Bryggeri stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 4 warning signs for Harboes Bryggeri (1 is concerning) 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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