Yahoo Finance Is Koninklijke DSM (AMS:DSM) A Risky Investment?
Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Koninklijke DSM N.V. (AMS:DSM) does use debt in its business. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for Koninklijke DSM
How Much Debt Does Koninklijke DSM Carry?
As you can see below, Koninklijke DSM had €2.65b of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. However, it also had €2.29b in cash, and so its net debt is €361.0m.
How Strong Is Koninklijke DSM's Balance Sheet?
The latest balance sheet data shows that Koninklijke DSM had liabilities of €2.70b due within a year, and liabilities of €3.37b falling due after that. Offsetting this, it had €2.29b in cash and €1.88b in receivables that were due within 12 months. So its liabilities total €1.90b more than the combination of its cash and short-term receivables.
Given Koninklijke DSM has a humongous market capitalization of €20.0b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Koninklijke DSM has net debt of just 0.25 times EBITDA, indicating that it is certainly not a reckless borrower. And this view is supported by the solid interest coverage, with EBIT coming in at 9.8 times the interest expense over the last year. But the bad news is that Koninklijke DSM has seen its EBIT plunge 15% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Koninklijke DSM's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Koninklijke DSM produced sturdy free cash flow equating to 63% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Our View
Based on what we've seen Koninklijke DSM is not finding it easy EBIT growth rate, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to cover its interest expense with its EBIT is pretty flash. When we consider all the elements mentioned above, it seems to us that Koninklijke DSM is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Koninklijke DSM's earnings per share history for free.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
