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Is KHD Humboldt Wedag International (ETR:KWG) A Risky Investment?

Simply Wall St

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. 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 note that KHD Humboldt Wedag International AG (ETR:KWG) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. 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 KHD Humboldt Wedag International

What Is KHD Humboldt Wedag International's Debt?

The chart below, which you can click on for greater detail, shows that KHD Humboldt Wedag International had €25.0m in debt in June 2019; about the same as the year before. However, it does have €60.7m in cash offsetting this, leading to net cash of €35.7m.

XTRA:KWG Historical Debt, February 17th 2020

A Look At KHD Humboldt Wedag International's Liabilities

Zooming in on the latest balance sheet data, we can see that KHD Humboldt Wedag International had liabilities of €84.6m due within 12 months and liabilities of €54.0m due beyond that. Offsetting these obligations, it had cash of €60.7m as well as receivables valued at €48.6m due within 12 months. So it has liabilities totalling €29.4m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since KHD Humboldt Wedag International has a market capitalization of €74.1m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, KHD Humboldt Wedag International also has more cash than debt, so we're pretty confident it can manage its debt safely. 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 KHD Humboldt Wedag International 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.

In the last year KHD Humboldt Wedag International wasn't profitable at an EBIT level, but managed to grow its revenue by 48%, to €170m. Shareholders probably have their fingers crossed that it can grow its way to profits.

So How Risky Is KHD Humboldt Wedag International?

Statistically speaking companies that lose money are riskier than those that make money. And we do note that KHD Humboldt Wedag International had negative earnings before interest and tax (EBIT), over the last year. Indeed, in that time it burnt through €22m of cash and made a loss of €33m. But the saving grace is the €35.7m on the balance sheet. That kitty means the company can keep spending for growth for at least two years, at current rates. KHD Humboldt Wedag International's revenue growth shone bright over the last year, so it may well be in a position to turn a profit in due course. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 5 warning signs with KHD Humboldt Wedag International (at least 1 which is potentially serious) , and understanding them should be part of your investment process.

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.

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.

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