Is OC Oerlikon (VTX: OERL) a risky investment?
Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital”. 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. Above all, OC Oerlikon Corporation SA (VTX: OERL) carries the debt. But the real question is whether this debt makes the business risky.
When Is Debt a Problem?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. 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. 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. When we look at debt levels, we first consider both liquidity and debt levels.
See our latest review for OC Oerlikon
What is OC Oerlikon’s debt?
The image below, which you can click for more details, shows that in June 2021 OC Oerlikon had a debt of CHF 739.0 million, up from CHF 572.0 million in one year. On the other hand, it has CHF 527.0 million in cash, resulting in net debt of around CHF 212.0 million.
A look at the responsibilities of OC Oerlikon
According to the last published balance sheet, OC Oerlikon had liabilities of 1.31 billion francs at less than 12 months and liabilities of 1.55 billion francs at more than 12 months. In compensation for these obligations, he had cash of CHF 527.0 million as well as receivables valued at CHF 662.0 million within 12 months. It therefore has liabilities totaling 1.66 billion francs more than its combined cash and short-term receivables.
While that may sound like a lot, it’s not so bad since OC Oerlikon has a market capitalization of CHF 3.36 billion, and it could therefore probably strengthen its balance sheet by raising capital if necessary. But we absolutely want to keep our eyes open for indications that its debt is too risky.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). 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).
OC Oerlikon has a low net debt to EBITDA ratio of just 0.70. And its EBIT easily covers its interest costs, which is 1,000 times the size. So we’re pretty relaxed about its ultra-conservative use of debt. Although OC Oerlikon recorded a loss in EBIT, last year it was also good to see that it generated 154 million CHF of EBIT in the last twelve months. The balance sheet is clearly the area you need to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether OC Oerlikon can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business can only pay off its debts with hard cash, not with book profits. It is therefore worth checking to what extent earnings before interest and taxes (EBIT) are backed by free cash flow. Fortunately for all shareholders, OC Oerlikon actually generated more free cash flow than EBIT over the past year. This kind of solid money conversion makes us as excited as the crowd when the beat drops at a Daft Punk concert.
Our point of view
Fortunately, OC Oerlikon’s impressive interest coverage means it has the upper hand on its debt. But frankly, we think his total passive level undermines that feeling a bit. When we consider the range of factors above, it seems that OC Oerlikon is quite reasonable with its use of debt. While this carries some risk, it can also improve returns for shareholders. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. For example, we discovered 2 warning signs for OC Oerlikon which you should know before investing here.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. 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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