Is Cargotec (HEL:CGCBV) A Risky Investment?

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.' 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. We can see that Cargotec Corporation (HEL:CGCBV) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Cargotec

What Is Cargotec's Debt?

The image below, which you can click on for greater detail, shows that Cargotec had debt of €684.2m at the end of September 2023, a reduction from €720.4m over a year. However, it does have €451.8m in cash offsetting this, leading to net debt of about €232.4m.

A Look At Cargotec's Liabilities

We can see from the most recent balance sheet that Cargotec had liabilities of €1.93b falling due within a year, and liabilities of €705.2m due beyond that. On the other hand, it had cash of €451.8m and €1.04b worth of receivables due within a year. So it has liabilities totalling €1.14b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Cargotec has a market capitalization of €3.44b, 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.

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).

Cargotec has a low net debt to EBITDA ratio of only 0.49. And its EBIT covers its interest expense a whopping 22.9 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Even more impressive was the fact that Cargotec grew its EBIT by 1,346% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Cargotec 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Cargotec recorded free cash flow worth 51% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Cargotec's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its EBIT growth rate also supports that impression! Zooming out, Cargotec seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Cargotec 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.