Klöckner & Co (ETR: KCO) has a somewhat strained balance sheet

Howard Marks put it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried. So it can be obvious that you need to consider debt, when you think about how risky a given stock is, because too much debt can sink a business. Like many other companies Klöckner & Co SE (ETR: KCO) uses debt. But should shareholders be concerned about its use of debt?

When is debt dangerous?

Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, debt can be an important tool in businesses, especially capital intensive businesses. When we think of a business’s use of debt, we first look at cash flow and debt together.

Discover our latest analysis for Klöckner & Co

How much debt does Klöckner & Co have?

The image below, which you can click for more details, shows that Klöckner & Co had a debt of 442.3 million euros at the end of September 2021, compared to 548.7 million euros over one year. On the other hand, it has 97.1 million euros in cash, leading to a net debt of approximately 345.3 million euros.

XTRA debt history: KCO on equity December 9, 2021

Is Klöckner & Co’s balance sheet healthy?

The latest balance sheet data shows that Klöckner & Co had debts of € 1.31 billion due within one year, and debts of € 720.3 million due thereafter. On the other hand, it had cash of € 97.1 million and € 1.05 billion in receivables within one year. Its liabilities therefore amount to € 878.7 million more than the combination of its cash and short-term receivables.

This deficit is substantial compared to its market capitalization of 1.02 billion euros, so he suggests shareholders keep an eye on Klöckner & Co’s use of debt. This suggests that shareholders would be heavily diluted if the company needed to consolidate its balance sheet quickly.

We measure a company’s indebtedness relative to its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating the ease with which its earnings before interest and taxes (EBIT ) covers its interests. costs (interest coverage). Thus, we look at debt versus earnings with and without amortization expenses.

Klöckner & Co’s net debt is only 0.48 times its EBITDA. And its EBIT covers its interest costs 69.5 times more. So we’re pretty relaxed about its ultra-conservative use of debt. It was also good to see that despite losing money on the EBIT line last year, Klöckner & Co has been a game-changer over the past 12 months, delivering EBIT of EUR 648 million. There is no doubt that we learn the most about debt from the balance sheet. But it is future profits, more than anything, that will determine Klöckner & Co’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.

But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. It is therefore worth checking to what extent profit before interest and taxes (EBIT) is supported by free cash flow. Over the past year, Klöckner & Co has published free cash flow of 14% of its EBIT, which is really quite low. This low level of cash conversion undermines its ability to manage and repay its debts.

Our point of view

While we have reservations about the ease with which Klöckner & Co is able to convert its EBIT to free cash flow, its interest hedging and net debt to EBITDA leads us to believe that we are relatively indifferent. We think Klöckner & Co’s debt makes it a bit risky, after considering the aforementioned data points together. This isn’t necessarily a bad thing, as leverage can increase returns on equity, but it’s something to be aware of. When analyzing debt levels, the balance sheet is the obvious place to start. However, not all investment risks lie on the balance sheet – far from it. To this end, you need to know the 2 warning signs we spotted with Klöckner & Co.

If you want to invest in companies that can generate profits without the burden of debt, 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 using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.

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