We Think SimCorp (CPH:SIM) Can Stay On Top Of Its 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies SimCorp A/S (CPH:SIM) makes use of debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for SimCorp

What Is SimCorp's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 SimCorp had €13.4m of debt, an increase on none, over one year. However, its balance sheet shows it holds €32.0m in cash, so it actually has €18.6m net cash.

How Strong Is SimCorp's Balance Sheet?

We can see from the most recent balance sheet that SimCorp had liabilities of €154.0m falling due within a year, and liabilities of €77.8m due beyond that. Offsetting these obligations, it had cash of €32.0m as well as receivables valued at €332.6m due within 12 months. So it can boast €132.7m more liquid assets than total liabilities.

This surplus suggests that SimCorp has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, SimCorp boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that SimCorp's load is not too heavy, because its EBIT was down 25% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine SimCorp's ability to maintain a healthy balance sheet going forward. 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. While SimCorp has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, SimCorp produced sturdy free cash flow equating to 74% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that SimCorp has net cash of €18.6m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of €63m, being 74% of its EBIT. So we don't have any problem with SimCorp's use of debt. 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 example, we've discovered 1 warning sign for SimCorp that you should be aware of before investing here.

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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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.