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Semperit Holding (VIE:SEM) Takes On Some Risk With Its Use Of Debt

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. 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. Importantly, Semperit Aktiengesellschaft Holding (VIE:SEM) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Semperit Holding

How Much Debt Does Semperit Holding Carry?

As you can see below, Semperit Holding had €233.8m of debt at June 2019, down from €279.8m a year prior. On the flip side, it has €160.9m in cash leading to net debt of about €72.9m.

WBAG:SEM Historical Debt, October 7th 2019

How Healthy Is Semperit Holding's Balance Sheet?

We can see from the most recent balance sheet that Semperit Holding had liabilities of €181.0m falling due within a year, and liabilities of €278.8m due beyond that. Offsetting these obligations, it had cash of €160.9m as well as receivables valued at €117.2m due within 12 months. So it has liabilities totalling €181.8m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of €257.2m. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Looking at its net debt to EBITDA of 1.4 and interest cover of 3.4 times, it seems to us that Semperit Holding is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. We also note that Semperit Holding improved its EBIT from a last year's loss to a positive €26m. 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 Semperit Holding 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. In the last year, Semperit Holding's free cash flow amounted to 43% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Both Semperit Holding's interest cover and its level of total liabilities were discouraging. But its not so bad at managing its debt, based on its EBITDA,. Taking the abovementioned factors together we do think Semperit Holding's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. Even though Semperit Holding lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check outhow earnings have been trending over the last few years.

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.