Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We note that Koenig & Bauer AG (ETR:SKB) has debt on its balance sheet. But the more important question is: what risk does this debt create?

When is debt a problem?

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 common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we look at debt levels, we first consider cash and debt levels, together.

Check out our latest analysis for Koenig & Bauer

What is Koenig & Bauer’s debt?

As you can see below, Koenig & Bauer had a debt of 132.3 million euros in September 2021, compared to 193.8 million euros the previous year. However, he also had €99.4m in cash, so his net debt is €32.9m.

How strong is Koenig & Bauer’s balance sheet?

We can see from the most recent balance sheet that Koenig & Bauer had liabilities of 518.7 million euros due in one year and liabilities of 412.2 million euros due beyond. In return for these bonds, it had cash of €99.4 million as well as receivables worth €109.3 million maturing in less than 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables by €722.2 million.

This deficit casts a shadow over the €341.2 million company, like a colossus dominating mere mortals. So we definitely think shareholders need to watch this one closely. Ultimately, Koenig & Bauer would likely need a significant recapitalization if its creditors demanded repayment.

We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). Thus, we consider debt to earnings with and without amortization and depreciation expense.

Koenig & Bauer has a very low debt to EBITDA ratio of 0.70, so it is strange to see low interest coverage, with last year’s EBIT only 2.2 times interest expense . So, one way or another, it is clear that debt levels are not negligible. Notably, Koenig & Bauer recorded a loss in EBIT last year, but improved it to a positive EBIT of EUR 18 million in the last twelve months. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine Koenig & Bauer’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.

Finally, a company can only repay its debts with cold hard cash, not with book profits. It is therefore worth checking how much of earnings before interest and tax (EBIT) is supported by free cash flow. Over the past year, Koenig & Bauer has actually produced more free cash flow than EBIT. There’s nothing better than cash coming in to stay in your lenders’ good books.

Our point of view

At first glance, Koenig & Bauer’s interest coverage left us hesitant about the stock, and its level of total liabilities was no more appealing than the single empty restaurant on the busiest night of the year. But on the bright side, its EBIT to free cash flow conversion is a good sign and makes us more optimistic. Once we consider all of the above factors together, it seems to us that Koenig & Bauer’s debt makes it a bit risky. Some people like that kind of risk, but we’re aware of the potential pitfalls, so we’d probably prefer it to take on less debt. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. For example, we found 1 warning sign for Koenig & Bauer which you should be aware of before investing here.

Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.

Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.

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.