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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, DEFAMA Deutsche Fachmarkt AG (ETR:DEF) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for DEFAMA Deutsche Fachmarkt
What Is DEFAMA Deutsche Fachmarkt's Debt?
The image below, which you can click on for greater detail, shows that at March 2019 DEFAMA Deutsche Fachmarkt had debt of €68.4m, up from €44.1m in one year. However, it also had €4.03m in cash, and so its net debt is €64.4m.
A Look At DEFAMA Deutsche Fachmarkt's Liabilities
We can see from the most recent balance sheet that DEFAMA Deutsche Fachmarkt had liabilities of €863.0k falling due within a year, and liabilities of €68.6m due beyond that. On the other hand, it had cash of €4.03m and €423.8k worth of receivables due within a year. So its liabilities total €65.1m more than the combination of its cash and short-term receivables.
Given this deficit is actually higher than the company's market capitalization of €59.7m, we think shareholders really should watch DEFAMA Deutsche Fachmarkt's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).