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. 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. As with many other companies Siemens Gamesa Renewable Energy, S.A. (BME:SGRE) makes use of debt. But the more important question is: how much risk is that debt creating?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Siemens Gamesa Renewable Energy's Debt?
As you can see below, Siemens Gamesa Renewable Energy had €1.48b of debt at December 2019, down from €1.96b a year prior. However, it does have €1.82b in cash offsetting this, leading to net cash of €341.6m.
How Healthy Is Siemens Gamesa Renewable Energy's Balance Sheet?
According to the last reported balance sheet, Siemens Gamesa Renewable Energy had liabilities of €7.96b due within 12 months, and liabilities of €2.96b due beyond 12 months. Offsetting these obligations, it had cash of €1.82b as well as receivables valued at €3.12b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €5.97b.
This deficit isn't so bad because Siemens Gamesa Renewable Energy is worth a massive €10.7b, 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. Despite its noteworthy liabilities, Siemens Gamesa Renewable Energy boasts net cash, so it's fair to say it does not have a heavy debt load!
Importantly, Siemens Gamesa Renewable Energy's EBIT fell a jaw-dropping 73% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Siemens Gamesa Renewable Energy 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Siemens Gamesa Renewable Energy 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. Over the last three years, Siemens Gamesa Renewable Energy saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
While Siemens Gamesa Renewable Energy does have more liabilities than liquid assets, it also has net cash of €341.6m. Despite the cash, we do find Siemens Gamesa Renewable Energy's EBIT growth rate concerning, so we're not particularly comfortable with the stock. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Siemens Gamesa Renewable Energy .
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.
If you spot an error that warrants correction, please contact the editor at email@example.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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