Is Brenntag (ETR:BNR) using too much debt?

Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We can see that Brenntag SE (ETR:BNR) uses debt in its business. But does this debt worry shareholders?

When is debt dangerous?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. 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. 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.

See our latest analysis for Brenntag

What is Brenntag’s debt?

You can click on the graph below for historical figures, but it shows that in June 2022 Brenntag had 2.63 billion euros in debt, an increase from 1.82 billion euros, on a year. However, he has €544.6 million in cash that offsets this, resulting in a net debt of around €2.09 billion.

XTRA: BNR debt to equity history as of September 11, 2022

A look at Brenntag’s responsibilities

We can see from the most recent balance sheet that Brenntag had liabilities of €4.22 billion due in one year, and liabilities of €2.69 billion due beyond. In return, it had 544.6 million euros in cash and 3.50 billion euros in receivables due within 12 months. It therefore has liabilities totaling 2.87 billion euros more than its cash and short-term receivables, combined.

This shortfall is not that bad as Brenntag is worth 10.5 billion euros and therefore could probably raise enough capital to shore up its balance sheet, should the need arise. But it is clear that it is essential to examine closely whether it can manage its debt without dilution.

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). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

We would say that Brenntag’s moderate net debt to EBITDA ratio (1.5) indicates caution in leverage. And its strong interest coverage of 16.5 times makes us even more comfortable. On top of that, we are pleased to report that Brenntag increased its EBIT by 57%, reducing the specter of future debt repayments. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Brenntag’s 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.

Finally, a company can only repay its debts with cold hard cash, not with book profits. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Brenntag has produced strong free cash flow equivalent to 64% of its EBIT, which is what we expected. This free cash flow puts the company in a good position to repay its debt, should it arise.

Our point of view

Brenntag’s interest coverage suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. And the good news does not stop there, since its EBIT growth rate also confirms this impression! Zooming out, Brenntag seems to be using debt quite sensibly; and that gets the green light from us. Although debt carries risks, when used wisely, it can also generate a higher return on equity. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. We have identified 3 warning signs with Brenntag (at least 2 that are potentially serious), and understanding them should be part of your investment process.

If you are interested in investing in companies 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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