Is Københavns Lufthavne (CPH:KBHL) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We note that Københavns Lufthavne A/S (CPH:KBHL) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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.

View our latest analysis for Københavns Lufthavne

What Is Københavns Lufthavne's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Københavns Lufthavne had debt of kr.9.34b, up from kr.8.32b in one year. Net debt is about the same, since the it doesn't have much cash.

A Look At Københavns Lufthavne's Liabilities

We can see from the most recent balance sheet that Københavns Lufthavne had liabilities of kr.1.33b falling due within a year, and liabilities of kr.10.4b due beyond that. Offsetting this, it had kr.20.0m in cash and kr.342.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr.11.3b.

Københavns Lufthavne has a market capitalization of kr.41.1b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Københavns Lufthavne shareholders face the double whammy of a high net debt to EBITDA ratio (11.7), and fairly weak interest coverage, since EBIT is just 0.39 times the interest expense. The debt burden here is substantial. Even worse, Københavns Lufthavne saw its EBIT tank 97% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that 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 Københavns Lufthavne 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Københavns Lufthavne burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Københavns Lufthavne's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least its level of total liabilities is not so bad. It's also worth noting that Københavns Lufthavne is in the Infrastructure industry, which is often considered to be quite defensive. Overall, it seems to us that Københavns Lufthavne's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. For example, we've discovered 2 warning signs for Københavns Lufthavne that you should be aware of before investing here.

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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