These 4 metrics indicate that Ringmetall (ETR:HP3A) 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. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We can see that Ringmetall SE (ETR:HP3A) uses debt in its business. But the more important question is: what risk does this debt create?

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. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. The first thing to do when considering how much debt a business has is to look at its cash and debt together.

Check out our latest analysis for Ringmetall

What is Ringmetall’s debt?

The image below, which you can click on for more details, shows that Ringmetall had debt of €19.3 million at the end of December 2021, a reduction of €20.7 million over one year. However, because it has a cash reserve of €4.57 million, its net debt is lower, at around €14.8 million.

XTRA:HP3A Debt to Equity Historical May 20, 2022

How strong is Ringmetall’s balance sheet?

Zooming in on the latest balance sheet data, we can see that Ringmetall had liabilities of €33.1 million due within 12 months and liabilities of €27.0 million due beyond. On the other hand, it has cash of €4.57 million and €25.6 million in receivables at less than one year. Its liabilities therefore total €30.0 million more than the combination of its cash and short-term receivables.

Ringmetall has a market capitalization of 129.9 million euros, so it could very likely raise funds to improve its balance sheet, should the need arise. But we definitely want to keep our eyes peeled for indications that its debt is too risky.

We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). 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 ).

Ringmetall’s net debt is only 0.66 times its EBITDA. And its EBIT covers its interest charges 22.4 times. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. What is even more impressive is that Ringmetall increased its EBIT by 223% year-over-year. This boost will make paying off debt even easier in the future. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Ringmetall can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, a company can only repay its debts with cash, not book profits. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Ringmetall has recorded free cash flow of 96% of its EBIT, which is higher than what we would normally expect. This positions him well to pay off debt if desired.

Our point of view

The good news is that Ringmetall’s demonstrated ability to cover interest costs with EBIT delights us like a fluffy puppy does a toddler. And this is only the beginning of good news since its conversion of EBIT into free cash flow is also very pleasing. Overall, we don’t think Ringmetall is taking bad risks, as its leverage looks modest. The balance sheet therefore seems rather healthy to us. 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. Be aware that Ringmetall displays 2 warning signs in our investment analysis and 1 of them does not suit us too much…

Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.

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.

Comments are closed.