These 4 Measures Indicate That H&K (EPA:MLHK) Is Using Debt Reasonably Well

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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, H&K AG (EPA:MLHK) does carry debt. But should shareholders be worried about its use of debt?

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When Is Debt A Problem?

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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is H&K's Debt?

The image below, which you can click on for greater detail, shows that H&K had debt of €95.2m at the end of December 2024, a reduction from €104.5m over a year. However, it does have €69.6m in cash offsetting this, leading to net debt of about €25.6m.

A Look At H&K's Liabilities

We can see from the most recent balance sheet that H&K had liabilities of €159.3m falling due within a year, and liabilities of €164.9m due beyond that. Offsetting these obligations, it had cash of €69.6m as well as receivables valued at €42.6m due within 12 months. So it has liabilities totalling €212.1m more than its cash and near-term receivables, combined.

Since publicly traded H&K shares are worth a total of €4.75b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Carrying virtually no net debt, H&K has a very light debt load indeed.

Check out our latest analysis for H&K

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).

With net debt sitting at just 0.42 times EBITDA, H&K is arguably pretty conservatively geared. And it boasts interest cover of 7.6 times, which is more than adequate. While H&K doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. When analysing debt levels, the balance sheet is the obvious place to start. But it is H&K's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, H&K recorded free cash flow worth 59% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

The good news is that H&K's demonstrated ability handle its debt, based on its EBITDA, delights us like a fluffy puppy does a toddler. And we also thought its conversion of EBIT to free cash flow was a positive. When we consider the range of factors above, it looks like H&K is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. For instance, we've identified 1 warning sign for H&K that 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.