ElringKlinger (ETR:ZIL2) has a somewhat strained balance sheet

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. Above all, ElringKlinger AG (ETR:ZIL2) is in debt. But does this debt worry shareholders?

What risk does debt carry?

Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. If things go really bad, lenders can take over the business. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first step when considering a company’s debt levels is to consider its cash and debt together.

Check out our latest analysis for ElringKlinger

What is ElringKlinger’s net debt?

The graph below, which you can click on for more details, shows that ElringKlinger had a debt of 470.6 million euros in June 2022; about the same as the previous year. On the other hand, he has €146.6 million in cash, resulting in a net debt of around €324.0 million.

XTRA: ZIL2 Debt to Equity August 23, 2022

How strong is ElringKlinger’s balance sheet?

We can see from the most recent balance sheet that ElringKlinger had liabilities of €628.6 million due within one year, and liabilities of €533.4 million due beyond. On the other hand, it had €146.6 million in cash and €281.1 million in receivables at less than one year. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables by €734.3 million.

The deficiency here weighs heavily on the company itself of 453.7 million euros, like a child struggling under the weight of a huge backpack full of books, his sports equipment and a trumpet. We would therefore be watching his balance sheet closely, no doubt. After all, ElringKlinger would likely need a major recapitalization if it were to pay its creditors today.

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 ).

With a net debt to EBITDA ratio of 2.8, ElringKlinger has a pretty notable amount of debt. On the positive side, its EBIT was 8.5 times its interest expense, and its net debt to EBITDA ratio was quite high, at 2.8. Shareholders should know that ElringKlinger’s EBIT fell 84% last year. If this earnings trend continues, paying off debt will be about as easy as herding cats on a roller coaster. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine ElringKlinger’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, while the taxman may love accounting profits, lenders only accept cash. It is therefore worth checking how much of this EBIT is supported by free cash flow. Fortunately for all shareholders, ElringKlinger has actually produced more free cash flow than EBIT over the past three years. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our point of view

To be frank, ElringKlinger’s EBIT growth rate and track record of keeping total liabilities under control makes us rather uncomfortable with its level of leverage. But on the bright side, its conversion from EBIT to free cash flow is a good sign and makes us more optimistic. Looking at the big picture, it seems clear to us that ElringKlinger’s use of debt creates risks for the business. If all goes well, it can pay off, but the downside of this debt is a greater risk of permanent losses. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. For example – ElringKlinger has 1 warning sign we think you should know.

If you are interested in investing in businesses that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.

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.

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