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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Georg Fischer AG (VTX:FI-N) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.
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What Is Georg Fischer's Net Debt?
The image below, which you can click on for greater detail, shows that Georg Fischer had debt of CHF824.0m at the end of June 2019, a reduction from CHF1.01b over a year. However, it also had CHF420.0m in cash, and so its net debt is CHF404.0m.
How Healthy Is Georg Fischer's Balance Sheet?
We can see from the most recent balance sheet that Georg Fischer had liabilities of CHF1.12b falling due within a year, and liabilities of CHF895.0m due beyond that. Offsetting these obligations, it had cash of CHF420.0m as well as receivables valued at CHF828.0m due within 12 months. So its liabilities total CHF768.0m more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Georg Fischer has a market capitalization of CHF3.32b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.
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.
Georg Fischer has a low net debt to EBITDA ratio of only 0.88. And its EBIT easily covers its interest expense, being 11.5 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the bad news is that Georg Fischer has seen its EBIT plunge 19% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Georg Fischer's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.