Is Fresenius SE KGaA (ETR:FRE) 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.” So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Like many other companies Fresenius SE & Co. KGaA (ETR:FRE) uses debt. But should shareholders worry about its use of debt?
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 usual (but still expensive) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
Check out our latest analysis for Fresenius SE KGaA
What is the net debt of Fresenius SE KGaA?
The graph below, which you can click on for more details, shows that Fresenius SE KGaA had a debt of 21.5 billion euros in June 2022; about the same as the previous year. However, he has €2.13 billion in cash that offsets this, resulting in a net debt of around €19.4 billion.
How strong is Fresenius SE KGaA’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Fresenius SE KGaA had liabilities of €12.5 billion due within 12 months and liabilities of €31.6 billion due beyond. In return, it had 2.13 billion euros in cash and 7.86 billion euros in receivables due within 12 months. Thus, its liabilities total 34.1 billion euros more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the 13.7 billion euro company, like a colossus towering above mere mortals. So we definitely think shareholders need to watch this one closely. After all, Fresenius SE KGaA would likely need a major recapitalization if it were to pay its creditors today.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
With a net debt to EBITDA ratio of 3.6, Fresenius SE KGaA has a fairly notable amount of debt. But the high interest coverage of 7.6 suggests it can easily repay that debt. Unfortunately, Fresenius SE KGaA has seen its EBIT fall by 9.1% over the last twelve months. If profits continue to fall, managing that debt will be as difficult as delivering hot soup on a unicycle. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Fresenius SE KGaA can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, while the taxman may love accounting profits, lenders only accept cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the last three years, Fresenius SE KGaA has recorded free cash flow of 71% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
We would go so far as to say that the level of total liabilities of Fresenius SE KGaA is disappointing. But at least it’s decent enough to convert EBIT to free cash flow; it’s encouraging. It should also be noted that Fresenius SE KGaA is in the healthcare sector, which is often seen as quite defensive. Once we consider all of the above factors together, it seems to us that Fresenius SE KGaA’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. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. To this end, you should be aware of the 1 warning sign we spotted with Fresenius SE KGaA.
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.