The external fund manager backed by Berkshire Hathaway’s Charlie Munger, Li Lu, makes no bones about it when he says ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.’ So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. As with many other companies Geratherm Medical AG (ETR:GME) makes use of debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Geratherm Medical Carry?
You can click the graphic below for the historical numbers, but it shows that as of June 2020 Geratherm Medical had €9.73m of debt, an increase on €5.18m, over one year. But it also has €11.1m in cash to offset that, meaning it has €1.36m net cash.
A Look At Geratherm Medical’s Liabilities
According to the last reported balance sheet, Geratherm Medical had liabilities of €7.19m due within 12 months, and liabilities of €8.89m due beyond 12 months. Offsetting these obligations, it had cash of €11.1m as well as receivables valued at €3.99m due within 12 months. So it has liabilities totalling €995.6k more than its cash and near-term receivables, combined.
This state of affairs indicates that Geratherm Medical’s balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it’s hard to imagine that the €50.5m company is struggling for cash, we still think it’s worth monitoring its balance sheet. While it does have liabilities worth noting, Geratherm Medical also has more cash than debt, so we’re pretty confident it can manage its debt safely.
Unfortunately, Geratherm Medical saw its EBIT slide 7.5% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. There’s no doubt that we learn most about debt from the balance sheet. But it is Geratherm Medical’s earnings that will influence how the balance sheet holds up in the future. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. While Geratherm Medical has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Geratherm Medical burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
We could understand if investors are concerned about Geratherm Medical’s liabilities, but we can be reassured by the fact it has has net cash of €1.36m. So although we see some areas for improvement, we’re not too worried about Geratherm Medical’s balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We’ve identified 4 warning signs with Geratherm Medical (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.
Of course, if you’re the type of investor who prefers buying stocks without the burden of debt, then don’t hesitate to discover our exclusive list of net cash growth stocks, today.
If you decide to trade Geratherm Medical, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Discounted cash flow calculation for every stock
Simply Wall St does a detailed discounted cash flow calculation every 6 hours for every stock on the market, so if you want to find the intrinsic value of any company just search here. It’s FREE.