David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 KSB SE & Co. KGaA (ETR:KSB) 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 examine debt levels, we first consider both cash and debt levels, together.
What Is KSB SE KGaA's Debt?
As you can see below, KSB SE KGaA had €79.4m of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. However, its balance sheet shows it holds €268.3m in cash, so it actually has €188.9m net cash.
How Healthy Is KSB SE KGaA's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that KSB SE KGaA had liabilities of €814.6m due within 12 months and liabilities of €660.2m due beyond that. On the other hand, it had cash of €268.3m and €723.7m worth of receivables due within a year. So it has liabilities totalling €482.8m more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of €497.6m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, KSB SE KGaA boasts net cash, so it's fair to say it does not have a heavy debt load!
And we also note warmly that KSB SE KGaA grew its EBIT by 14% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if KSB SE KGaA 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. While KSB SE KGaA has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, KSB SE KGaA created free cash flow amounting to 11% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
Although KSB SE KGaA's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €188.9m. And it also grew its EBIT by 14% over the last year. So although we see some areas for improvement, we're not too worried about KSB SE KGaA's balance sheet. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of KSB SE KGaA's earnings per share history for free.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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 firstname.lastname@example.org. 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.