Legendary fund manager Li Lu (whom Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. It’s only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. Like many other companies HOCHTIEF Aktiengesellschaft (ETR: HOT) uses debt. But the most important question is: what risk does this debt create?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. When we think of a business’s use of debt, we first look at cash flow and debt together.

Discover our latest analysis for HOCHTIEF

What is HOCHTIEF’s debt?

As you can see below, HOCHTIEF had a debt of 5.52 billion euros in March 2021, up from 6.42 billion euros the previous year. However, he also had 5.32 billion euros in cash, so his net debt is 194.8 million euros.

How healthy is HOCHTIEF’s balance sheet?

Zooming in on the latest balance sheet data, we can see that HOCHTIEF had a liability of € 9.92 billion due within 12 months and a liability of € 5.71 billion due beyond. In compensation for these commitments, it had cash of € 5.32 billion as well as receivables valued at € 5.81 billion maturing in 12 months. Its liabilities therefore amount to € 4.51 billion more than the combination of its cash and short-term receivables.

When you consider that this deficit exceeds the company’s $ 4.47 billion market capitalization, you might be inclined to carefully review the balance sheet. In the scenario where the company had to clean up its balance sheet quickly, it seems likely that shareholders would suffer a significant dilution. The balance sheet is clearly the area you need to focus on when analyzing debt. But it is future profits, more than anything, that will determine HOCHTIEF’s ability to maintain a healthy balance sheet in the future. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Over 12 months, HOCHTIEF recorded a loss in EBIT, and saw its turnover fall to € 22 billion, a decrease of 17%. This is not what we hope to see.

Emptor Warning

While HOCHTIEF’s declining income is about as comforting as a wet blanket, its earnings before interest and taxes (EBIT) can be said to be even less attractive. Its EBIT loss amounted to € 590 million. Considering that aside from the liabilities mentioned above, we are nervous about the business. We would like to see big improvements in the short term before we get too interested in the title. But on the bright side, the company actually made a statutory profit of 366 million euros and free cash flow of 190 million euros. So one could argue that there is still a chance that he could put things on the right track. The balance sheet is clearly the area you need to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. Example: we have spotted 4 warning signs for HOCHTIEF you must be aware of this, and one of them must not be ignored.

Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash growth stocks today.

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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 material. Simply Wall St has no position in any of the stocks mentioned.
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