Is Stabilus (ETR:STM) A Risky Investment?
Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Stabilus S.A. (ETR:STM) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.
See our latest analysis for Stabilus
What Is Stabilus's Net Debt?
As you can see below, Stabilus had €332.6m of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. However, because it has a cash reserve of €126.2m, its net debt is less, at about €206.4m.
How Healthy Is Stabilus's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Stabilus had liabilities of €154.9m due within 12 months and liabilities of €443.6m due beyond that. On the other hand, it had cash of €126.2m and €134.6m worth of receivables due within a year. So it has liabilities totalling €337.8m more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Stabilus has a market capitalization of €1.10b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Stabilus's net debt is only 1.2 times its EBITDA. And its EBIT easily covers its interest expense, being 12.0 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the other side of the story is that Stabilus saw its EBIT decline by 7.3% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Stabilus 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. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Stabilus recorded free cash flow worth 68% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Our View
On our analysis Stabilus's interest cover should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to grow its EBIT. Considering this range of data points, we think Stabilus is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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 Stabilus's earnings per share history for free.
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.
