BayWa (ETR: BYW) takes some risk with its use of debt
Warren Buffett said: “Volatility is far from synonymous with risk”. 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. We can see that BayWa Aktiengesellschaft (ETR: BYW) uses debt in its business. But should shareholders be concerned about its use of debt?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. 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, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
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What is BayWa’s debt?
The image below, which you can click for more details, shows that BayWa had a debt of 3.06 billion euros at the end of March 2021, a reduction from 3.62 billion euros on a year. However, because it has a cash reserve of â¬ 190.9 million, its net debt is lower, at around â¬ 2.87 billion.
How strong is BayWa’s balance sheet?
Zooming in on the latest balance sheet data, we can see that BayWa had a liability of â¬ 4.99 billion due within 12 months and a liability of â¬ 3.09 billion due beyond. On the other hand, it had cash of â¬ 190.9 million and â¬ 2.24 billion in receivables within one year. Its liabilities thus exceed the sum of its cash and its receivables (short term) by 5.66 billion euros.
The deficit here weighs heavily on the â¬ 1.31 billion company itself, as if a child struggles under the weight of a huge backpack full of books, his gym equipment and a trumpet. We therefore believe that shareholders should watch it closely. After all, BayWa would likely need a major recapitalization if it were to pay its creditors today.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
With a net debt to EBITDA ratio of 5.8, it’s fair to say that BayWa has significant debt. But the good news is that he enjoys a fairly comforting 3.2x interest coverage, which suggests he can meet his obligations responsibly. However, the bright side is that BayWa achieved a positive EBIT of 315 million euros in the last twelve months, an improvement over the loss of the previous year. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future profits, more than anything, that will determine BayWa’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.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. It is therefore important to check to what extent its earnings before interest and taxes (EBIT) are converted into actual free cash flow. Over the past year, BayWa has actually generated more free cash flow than EBIT. This kind of strong cash generation warms our hearts like a puppy in a bumblebee costume.
Our point of view
To be frank, BayWa’s net debt to EBITDA and its track record of controlling its total liabilities makes us rather uncomfortable with its debt levels. But on the positive side, its conversion from EBIT to free cash flow is a good sign and makes us more optimistic. Overall, we think it’s fair to say that BayWa has enough debt that there is real risk around the balance sheet. If all goes well, this should increase returns, but on the other hand, the risk of permanent capital loss is increased by debt. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. For example – BayWa has 1 warning sign we think you should be aware.
At the end of the day, it’s often best to focus on businesses that don’t have net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares 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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