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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, EnviTec Biogas AG (ETR:ETG) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for EnviTec Biogas
How Much Debt Does EnviTec Biogas Carry?
The image below, which you can click on for greater detail, shows that EnviTec Biogas had debt of €54.1m at the end of June 2019, a reduction from €70.7m over a year. On the flip side, it has €28.1m in cash leading to net debt of about €26.0m.
How Healthy Is EnviTec Biogas's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that EnviTec Biogas had liabilities of €56.0m due within 12 months and liabilities of €46.4m due beyond that. Offsetting this, it had €28.1m in cash and €26.8m in receivables that were due within 12 months. So it has liabilities totalling €47.5m more than its cash and near-term receivables, combined.
This deficit isn't so bad because EnviTec Biogas is worth €179.7m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.