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. 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. As with many other companies Klingelnberg AG (VTX:KLIN) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is Klingelnberg's Net Debt?
The image below, which you can click on for greater detail, shows that Klingelnberg had debt of €6.46m at the end of March 2019, a reduction from €28.3m over a year. But it also has €28.7m in cash to offset that, meaning it has €22.2m net cash.
A Look At Klingelnberg's Liabilities
According to the last reported balance sheet, Klingelnberg had liabilities of €71.6m due within 12 months, and liabilities of €20.8m due beyond 12 months. Offsetting this, it had €28.7m in cash and €76.5m in receivables that were due within 12 months. So it can boast €12.7m more liquid assets than total liabilities.
This short term liquidity is a sign that Klingelnberg could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Klingelnberg boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that Klingelnberg has boosted its EBIT by 30%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Klingelnberg can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Klingelnberg may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Klingelnberg's free cash flow amounted to 29% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
While it is always sensible to investigate a company's debt, in this case Klingelnberg has €22.2m in net cash and a decent-looking balance sheet. And we liked the look of last year's 30% year-on-year EBIT growth. So we don't think Klingelnberg's use of debt is risky. Given Klingelnberg 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, 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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