Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Sixt Leasing SE (ETR:LNSX) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.
How Much Debt Does Sixt Leasing Carry?
The image below, which you can click on for greater detail, shows that Sixt Leasing had debt of €946.4m at the end of June 2019, a reduction from €1.08b over a year. And it doesn't have much cash, so its net debt is about the same.
A Look At Sixt Leasing's Liabilities
Zooming in on the latest balance sheet data, we can see that Sixt Leasing had liabilities of €346.3m due within 12 months and liabilities of €780.2m due beyond that. Offsetting this, it had €1.27m in cash and €126.1m in receivables that were due within 12 months. So its liabilities total €999.1m more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the €196.0m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt At the end of the day, Sixt Leasing would probably need a major re-capitalization if its creditors were to demand repayment.
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 a net debt to EBITDA ratio of 20.9, it's fair to say Sixt Leasing does have a significant amount of debt. However, its interest coverage of 3.7 is reasonably strong, which is a good sign. More concerning, Sixt Leasing saw its EBIT drop by 5.4% in the last twelve months. If it keeps going like that paying off its debt will be like running on a treadmill -- a lot of effort for not much advancement. 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 Sixt Leasing 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Sixt Leasing burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
To be frank both Sixt Leasing's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And even its interest cover fails to inspire much confidence. Taking into account all the aforementioned factors, it looks like Sixt Leasing has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. Given Sixt Leasing has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
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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