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Is EnviTec Biogas (ETR:ETG) A Risky Investment?

Simply Wall St

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, EnviTec Biogas AG (ETR:ETG) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

View our latest analysis for EnviTec Biogas

How Much Debt Does EnviTec Biogas Carry?

The image below, which you can click on for greater detail, shows that EnviTec Biogas had debt of €54.1m at the end of June 2019, a reduction from €70.7m over a year. On the flip side, it has €28.1m in cash leading to net debt of about €26.0m.

XTRA:ETG Historical Debt, October 19th 2019

How Healthy Is EnviTec Biogas's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that EnviTec Biogas had liabilities of €56.0m due within 12 months and liabilities of €46.4m due beyond that. Offsetting this, it had €28.1m in cash and €26.8m in receivables that were due within 12 months. So it has liabilities totalling €47.5m more than its cash and near-term receivables, combined.

This deficit isn't so bad because EnviTec Biogas is worth €179.7m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

EnviTec Biogas has net debt of just 0.97 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 9.5 times, which is more than adequate. But the other side of the story is that EnviTec Biogas saw its EBIT decline by 4.0% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since EnviTec Biogas will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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. During the last three years, EnviTec Biogas generated free cash flow amounting to a very robust 88% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Happily, EnviTec Biogas's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its EBIT growth rate. All these things considered, it appears that EnviTec Biogas can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check EnviTec Biogas's dividend history, without delay!

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.