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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. Importantly, Dinkelacker AG (BST:DWB) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for Dinkelacker
How Much Debt Does Dinkelacker Carry?
As you can see below, at the end of March 2019, Dinkelacker had €38.4m of debt, up from €21.6m a year ago. Click the image for more detail. However, it does have €1.73m in cash offsetting this, leading to net debt of about €36.7m.
How Healthy Is Dinkelacker's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Dinkelacker had liabilities of €512.0k due within 12 months and liabilities of €62.4m due beyond that. Offsetting this, it had €1.73m in cash and €133.0k in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €61.0m.
Given Dinkelacker has a market capitalization of €521.1m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Dinkelacker's net debt is 2.7 times its EBITDA, which is a significant but still reasonable amount of leverage. But its EBIT was about 20.7 times its interest expense, implying the company isn't really paying full freight on that debt. Even if not sustainable, that is a good sign. Dinkelacker grew its EBIT by 6.4% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Dinkelacker's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.