Does Dätwyler Holding (VTX:DAE) have a healthy balance sheet?

Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. 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 Dätwyler Holding AG (VTX:DAE) has debt on its balance sheet. But does this debt worry shareholders?

When is debt dangerous?

Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. 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. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.

Discover our latest analysis for Dätwyler Holding

What is Dätwyler Holding’s debt?

The image below, which you can click on for more details, shows that in June 2022, Dätwyler Holding had a debt of CHF 721.5 million, compared to CHF 203.1 million in one year. On the other hand, it has 93.0 million francs in cash, which results in a net debt of approximately 628.5 million francs.

SWX:DAE Debt to Equity History September 20, 2022

How healthy is Dätwyler Holding’s balance sheet?

We can see from the most recent balance sheet that Dätwyler Holding had liabilities of CHF 769.1 million maturing in one year and liabilities of CHF 170.7 million maturing beyond. In return, it had 93.0 million francs in cash and 284.2 million francs in receivables due within 12 months. Thus, its liabilities total 562.6 million francs more than the combination of its cash and short-term receivables.

While that might sound like a lot, it’s not too bad since Dätwyler Holding has a market capitalization of 2.75 billion francs and therefore could probably strengthen its balance sheet by raising capital if necessary. However, it is always worth taking a close look at its ability to repay debt.

We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).

Dätwyler Holding’s net debt is 3.0 times its EBITDA, which represents significant but still reasonable leverage. But its EBIT was around 47.6 times its interest expense, implying that the company isn’t really paying a high cost to maintain that level of leverage. Even if the low cost turns out to be unsustainable, that’s a good sign. Unfortunately, Dätwyler Holding has seen its EBIT fall by 7.4% over the past twelve months. If earnings 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 Dätwyler Holding 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. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Dätwyler Holding’s free cash flow has been 45% of its EBIT, less than expected. This low cash conversion makes debt management more difficult.

Our point of view

Regarding the balance sheet, the most notable positive for Dätwyler Holding is the fact that it seems able to cover its interest charges with its EBIT with confidence. But the other factors we noted above weren’t so encouraging. For example, it looks like it has to struggle a bit to increase its EBIT. Considering all the factors mentioned above, we feel somewhat cautious about Dätwyler Holding’s use of debt. 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. For example, we have identified 2 warning signs for Dätwyler Holding (1 is significant) which you should be aware of.

In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.

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.

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