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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Sartorius Stedim Biotech S.A. (EPA:DIM) 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.
What Is Sartorius Stedim Biotech's Debt?
As you can see below, at the end of September 2023, Sartorius Stedim Biotech had €3.67b of debt, up from €1.08b a year ago. Click the image for more detail. However, it also had €118.7m in cash, and so its net debt is €3.56b.
How Healthy Is Sartorius Stedim Biotech's Balance Sheet?
We can see from the most recent balance sheet that Sartorius Stedim Biotech had liabilities of €853.6m falling due within a year, and liabilities of €4.48b due beyond that. Offsetting these obligations, it had cash of €118.7m as well as receivables valued at €333.9m due within 12 months. So its liabilities total €4.88b more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Sartorius Stedim Biotech has a huge market capitalization of €19.0b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Sartorius Stedim Biotech's debt is 4.0 times its EBITDA, and its EBIT cover its interest expense 5.1 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Shareholders should be aware that Sartorius Stedim Biotech's EBIT was down 32% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Sartorius Stedim Biotech's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Sartorius Stedim Biotech's free cash flow amounted to 24% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
We'd go so far as to say Sartorius Stedim Biotech's EBIT growth rate was disappointing. Having said that, its ability to handle its total liabilities isn't such a worry. Once we consider all the factors above, together, it seems to us that Sartorius Stedim Biotech's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Sartorius Stedim Biotech (of which 1 makes us a bit uncomfortable!) you should know about.
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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