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 can see that Staatl. Mineralbrunnen AG (MUN:SLB) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt A Problem?
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 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is Staatl. Mineralbrunnen's Net Debt?
The image below, which you can click on for greater detail, shows that Staatl. Mineralbrunnen had debt of €969.6k at the end of December 2018, a reduction from €1.38m over a year. On the flip side, it has €857.1k in cash leading to net debt of about €112.5k.
A Look At Staatl. Mineralbrunnen's Liabilities
Zooming in on the latest balance sheet data, we can see that Staatl. Mineralbrunnen had liabilities of €2.40m due within 12 months and liabilities of €3.82m due beyond that. Offsetting these obligations, it had cash of €857.1k as well as receivables valued at €1.18m due within 12 months. So its liabilities total €4.18m more than the combination of its cash and short-term receivables.
Given Staatl. Mineralbrunnen has a market capitalization of €53.7m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. But either way, Staatl. Mineralbrunnen has virtually no net debt, so it's fair to say it does not have a heavy debt load!
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Staatl. Mineralbrunnen has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.037 and EBIT of 18.6 times the interest expense. Indeed relative to its earnings its debt load seems light as a feather. And we also note warmly that Staatl. Mineralbrunnen grew its EBIT by 19% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is Staatl. Mineralbrunnen's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Staatl. Mineralbrunnen recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
The good news is that Staatl. Mineralbrunnen's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. Looking at all the aforementioned factors together, it strikes us that Staatl. Mineralbrunnen can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. Over time, share prices tend to follow earnings per share, so if you're interested in Staatl. Mineralbrunnen, you may well want to click here to check an interactive graph of its earnings per share history.
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.
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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.