Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” 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 can see that Aalberts AG (AMS:AALB) uses debt in its business. But should shareholders worry about its use of debt?
When is debt a problem?
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. Of course, many companies use debt to finance their growth, without any negative consequences. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for Aalberts
What is Aalberts net debt?
You can click on the graph below for historical figures, but it shows Aalberts had €383.7m in debt in December 2021, up from €507.9m a year earlier. However, he has €72.0 million in cash to offset this, resulting in a net debt of around €311.7 million.
A look at Aalberts’ responsibilities
According to the last published balance sheet, Aalberts had liabilities of €946.1 million maturing within 12 months and liabilities of €525.5 million maturing beyond 12 months. In return for these bonds, it had cash of €72.0 million as well as receivables worth €382.4 million maturing in less than 12 months. It therefore has liabilities totaling 1.02 billion euros more than its cash and short-term receivables, combined.
Given that Aalberts has a market cap of €5.17 billion, it’s hard to believe that these liabilities pose a big threat. That said, it is clear that we must continue to monitor its record, lest it deteriorate.
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 ).
Aalberts’ net debt is only 0.64 times its EBITDA. And its EBIT covers its interest charges 26.1 times. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. On top of that, Aalberts has grown its EBIT by 89% over the last twelve months, and this growth will make it easier to manage its debt. 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 Aalberts can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Aalberts has recorded free cash flow of 76% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
The good news is that Aalberts’ demonstrated ability to cover his interest charges with his EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, since its EBIT growth rate also confirms this impression! Given this range of factors, it seems to us that Aalberts is quite cautious with its debt, and the risks appear to be well contained. So we are not worried about using a little leverage on the balance sheet. 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. Know that Aalberts shows 2 warning signs in our investment analysis you should know…
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.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.
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.