We believe Koninklijke DSM (AMS: DSM) can stay on top of its debt

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Legendary fund manager Li Lu (who 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. Above all, Koninklijke DSM NV (AMS: DSM) carries the debt. But should shareholders be concerned about its use of debt?

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. If things really go wrong, lenders can take over the business. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we think of a business’s use of debt, we first look at cash flow and debt together.

See our latest review for Koninklijke DSM

How much debt does Koninklijke DSM have?

As you can see below, Koninklijke DSM had 3.12 billion euros in debt in June 2021, up from 3.88 billion euros the previous year. However, he also had € 1.86 billion in cash, so his net debt is € 1.27 billion.

ENXTAM: History of debt on equity of DSM October 1, 2021

How strong is Koninklijke DSM’s balance sheet?

According to the latest published balance sheet, Koninklijke DSM had liabilities of 2.33 billion euros at 12 months and liabilities of 4.17 billion euros over 12 months. On the other hand, he had cash of 1.86 billion euros and 1.74 billion euros in receivables less than one year. It therefore has total liabilities of 2.90 billion euros more than its combined cash and short-term receivables.

Of course, Koninklijke DSM has a titanic market cap of 29.5 billion euros, so this liability is probably manageable. But there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward.

In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

Koninklijke DSM has a net debt of only 0.92 times EBITDA, indicating that he is certainly not a reckless borrower. And it has 7.3 times interest coverage, which is more than enough. Fortunately, Koninklijke DSM increased its EBIT by 5.8% last year, which makes this debt load even more manageable. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future profits, more than anything, that will determine Koninklijke DSM’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.

Finally, a business needs free cash flow to repay its debts; accounting profits are not enough. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, Koninklijke DSM has achieved free cash flow totaling 99% of its EBIT, which is higher than what we normally expected. This puts him in a very strong position to pay off the debt.

Our point of view

Fortunately, Koninklijke DSM’s impressive conversion of EBIT to free cash flow means that it has the upper hand over its debt. And that’s just the start of the good news as its net debt to EBITDA is also very encouraging. Overall, we think Koninklijke DSM’s use of debt seems quite reasonable and we don’t care. After all, reasonable leverage can increase returns on equity. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. To do this, you need to know the 1 warning sign we spotted with Koninklijke DSM.

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 net growth stocks today.

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 the mentioned stocks.

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