Warren Buffett said: “Volatility is far from synonymous with risk. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We can see that Bayerische Motoren Werke Aktiengesellschaft (ETR:BMW) uses debt in its business. But the real question is whether this debt makes the business risky.
When is debt dangerous?
Debt helps a business until the business struggles to pay it back, either with new capital or with free 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, many companies use debt to finance their growth, without any negative consequences. When we look at debt levels, we first consider cash and debt levels, together.
Check out our latest analysis for Bayerische Motoren Werke
What is Bayerische Motoren Werke’s debt?
The image below, which you can click on for more details, shows that Bayerische Motoren Werke had a debt of 104.5 billion euros at the end of September 2021, compared to 112.1 billion euros in one year. However, he also had 14.3 billion euros in cash, and his net debt is therefore 90.2 billion euros.
A look at the responsibilities of Bayerische Motoren Werke
We can see from the most recent balance sheet that Bayerische Motoren Werke had liabilities of 73.9 billion euros due in one year, and liabilities of 78.1 billion euros due beyond. In compensation for these obligations, it had cash of 14.3 billion euros as well as receivables worth 2.77 billion euros at less than 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables by €134.9 billion.
This deficit casts a shadow over the 60.7 billion euro enterprise, like a colossus towering above mere mortals. We would therefore be watching his balance sheet closely, no doubt. After all, Bayerische Motoren Werke would probably need a major recapitalization if it had to pay its creditors today.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Strangely, Bayerische Motoren Werke has a sky-high EBITDA ratio of 5.6, implying high debt, but high interest coverage of 54.2. Either he has access to very cheap long-term debt, or his interest costs will increase! Fortunately, Bayerische Motoren Werke is growing its EBIT faster than former Australian Prime Minister Bob Hawke dropped a yard glass, with a 153% gain over the last twelve months. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Bayerische Motoren Werke 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 cold hard cash, not with book profits. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Bayerische Motoren Werke has recorded a free cash flow of 46% of its EBIT, which is lower than expected. It’s not great when it comes to paying off debt.
Our point of view
While the level of total liabilities of Bayerische Motoren Werke makes us nervous. Interest coverage and EBIT growth rate were encouraging signs. Taking into account the above factors, we believe that Bayerische Motoren Werke’s debt poses certain risks for the company. So even if this leverage increases return on equity, we wouldn’t really want to see it increase from now on. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. Example: we have identified 3 warning signs for Bayerische Motoren Werke you should know, and 2 of them make us uncomfortable.
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.
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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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