These 4 measures indicate that Stabilus (ETR:STM) is using debt safely
Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We note that Stabilus SA (ETR:STM) has debt on its balance sheet. But the real question is whether this debt makes the business risky.
Why is debt risky?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, many companies use debt to finance their growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.
See our latest analysis for Stabilus
What is Stabilus’ net debt?
The graph below, which you can click on for more details, shows that Stabilus had €348.2 million in debt in March 2022; about the same as the previous year. However, because it has a cash reserve of €203.8 million, its net debt is lower, at approximately €144.4 million.
How strong is Stabilus’ balance sheet?
According to the last published balance sheet, Stabilus had liabilities of €204.6 million maturing within 12 months and liabilities of €476.8 million maturing beyond 12 months. On the other hand, it had €203.8 million in cash and €179.0 million in receivables at less than one year. It therefore has liabilities totaling €298.6 million more than its cash and short-term receivables, combined.
This shortfall is not that bad as Stabilus is worth 1.27 billion euros and therefore could probably raise enough capital to shore up its balance sheet, should the need arise. However, it is always worth taking a close look at its ability to repay debt.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
Stabilus’ net debt is only 0.88 times its EBITDA. And its EBIT easily covers its interest charges, which is 12.7 times the size. So we’re pretty relaxed about his super-conservative use of debt. On top of that, Stabilus has grown its EBIT by 33% over the last twelve months, and this growth will make it easier to manage its debt. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine Stabilus’ ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
But our last consideration is also important, because a company cannot pay off its debts with paper profits; he needs cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Stabilus has recorded free cash flow of 73% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This cold hard cash allows him to reduce his debt whenever he wants.
Our point of view
Fortunately, Stabilus’ impressive interest coverage means it has the upper hand on its debt. And the good news does not stop there, since its EBIT growth rate also confirms this impression! Overall, we think Stabilus’ use of debt seems entirely reasonable and we’re not worried about that. After all, reasonable leverage can increase return on equity. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. Example: we have identified 1 warning sign for Stabilus you should be aware.
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.