Is Kontron (ETR:SANT) using too much debt?
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. Above all, Kontron AG (ETR:SANT) is in debt. But the more important question is: what risk does this debt create?
When is debt dangerous?
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, many companies use debt to finance their growth, without any negative consequences. When we think about a company’s use of debt, we first look at cash and debt together.
Check out our latest analysis for Kontron
What is Kontron’s net debt?
The chart below, which you can click on for more details, shows that Kontron had €310.1 million in debt as of March 2022; about the same as the previous year. However, he also had €224.3 million in cash, so his net debt is €85.8 million.
How healthy is Kontron’s balance sheet?
The latest balance sheet data shows that Kontron had liabilities of €530.8 million due within one year and liabilities of €331.9 million falling due thereafter. In return for these obligations, it had cash of €224.3 million as well as receivables worth €326.0 million at less than 12 months. It therefore has liabilities totaling 312.4 million euros more than its cash and short-term receivables, combined.
Kontron has a market capitalization of 851.4 million euros, so it could very likely raise funds to improve its balance sheet, should the need arise. However, it is always worth taking a close look at your ability to repay debt.
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). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Given its net debt to EBITDA ratio of 1.3 and interest coverage of 4.8 times, it seems to us that Kontron is probably using debt quite sensibly. We therefore recommend that you closely monitor the impact of financing costs on the company. Importantly, Kontron’s EBIT has fallen by 30% over the last twelve months. If this decline continues, it will be more difficult to repay debts than to sell foie gras at a vegan convention. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Kontron’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Kontron has generated free cash flow of a very strong 99% of its EBIT, more than we expected. This puts him in a very strong position to repay his debt.
Our point of view
From what we’ve seen, Kontron doesn’t find it easy given its EBIT growth rate, but the other factors we’ve considered give us cause for optimism. In particular, we are blown away by its conversion of EBIT to free cash flow. Looking at all this data, we feel a bit cautious about Kontron’s debt levels. While we understand that debt can improve return on equity, we suggest shareholders keep a close eye on their level of debt, lest it increase. 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. To this end, you should be aware of the 3 warning signs we spotted with Kontron.
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.
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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.