We Think Obrascón Huarte Lain (BME:OHLA) Is Taking Some Risk With Its 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.' 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 can see that Obrascón Huarte Lain, S.A. (BME:OHLA) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Obrascón Huarte Lain

What Is Obrascón Huarte Lain's Debt?

As you can see below, at the end of September 2023, Obrascón Huarte Lain had €519.1m of debt, up from €475.8m a year ago. Click the image for more detail. However, it also had €448.2m in cash, and so its net debt is €70.9m.

How Healthy Is Obrascón Huarte Lain's Balance Sheet?

According to the last reported balance sheet, Obrascón Huarte Lain had liabilities of €2.09b due within 12 months, and liabilities of €706.7m due beyond 12 months. Offsetting this, it had €448.2m in cash and €1.53b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €825.2m.

This deficit casts a shadow over the €256.8m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Obrascón Huarte Lain would likely require a major re-capitalisation if it had to pay its creditors today.

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).

Given net debt is only 0.60 times EBITDA, it is initially surprising to see that Obrascón Huarte Lain's EBIT has low interest coverage of 1.1 times. So one way or the other, it's clear the debt levels are not trivial. Importantly, Obrascón Huarte Lain grew its EBIT by 43% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Obrascón Huarte Lain 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Obrascón Huarte Lain actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

While Obrascón Huarte Lain's level of total liabilities has us nervous. To wit both its conversion of EBIT to free cash flow and EBIT growth rate were encouraging signs. We think that Obrascón Huarte Lain's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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 1 warning sign for Obrascón Huarte Lain 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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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.