Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, Brødrene Hartmann A/S (CPH:HART) does carry debt. But should shareholders be worried about its use of debt?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.
What Is Brødrene Hartmann's Debt?
As you can see below, at the end of March 2021, Brødrene Hartmann had kr.781.9m of debt, up from kr.611.3m a year ago. Click the image for more detail. On the flip side, it has kr.115.0m in cash leading to net debt of about kr.666.9m.
How Strong Is Brødrene Hartmann's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Brødrene Hartmann had liabilities of kr.506.7m due within 12 months and liabilities of kr.887.6m due beyond that. On the other hand, it had cash of kr.115.0m and kr.578.7m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr.700.6m.
Brødrene Hartmann has a market capitalization of kr.2.97b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
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).
Brødrene Hartmann has a low net debt to EBITDA ratio of only 1.1. And its EBIT covers its interest expense a whopping 43.1 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Brødrene Hartmann grew its EBIT by 61% 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 you can't view debt in total isolation; since Brødrene Hartmann 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Brødrene Hartmann's free cash flow amounted to 30% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Happily, Brødrene Hartmann's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. Taking all this data into account, it seems to us that Brødrene Hartmann takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Brødrene Hartmann has 2 warning signs we think you should be aware of.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.
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