We think SAP (ETR:SAP) can get its debt under control

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David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the 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 SAP SE (ETR:SAP) has a debt on its balance sheet. But the real question is whether this debt makes the business risky.

Why is debt risky?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

Discover our latest analysis for SAP

What is SAP’s debt?

As you can see below, SAP had 11.7 billion euros in debt in June 2022, compared to 13.1 billion euros the previous year. However, he has €8.48 billion in cash that offsets this, resulting in a net debt of around €3.22 billion.

XTRA: SAP Debt to Equity History as of July 31, 2022

How healthy is SAP’s balance sheet?

The latest balance sheet data shows that SAP had liabilities of 20.9 billion euros due within one year, and liabilities of 11.9 billion euros falling due thereafter. On the other hand, it had 8.48 billion euros in cash and 9.53 billion euros in receivables at less than one year. It therefore has liabilities totaling 14.8 billion euros more than its cash and short-term receivables, combined.

Given that SAP has a colossal market cap of €106.1 billion, it’s hard to believe that these liabilities pose a threat. However, we think it’s worth keeping an eye on the strength of its balance sheet, as it can change over time.

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). Thus, we consider debt to earnings with and without amortization and depreciation expense.

SAP has a low net debt to EBITDA ratio of just 0.51. And its EBIT easily covers its interest costs, which is 39.7 times the size. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Fortunately, SAP’s burden is not too heavy, as its EBIT fell by 23% compared to last year. When a company sees its profit reservoir, it can sometimes see its relationship with its lenders turn sour. When analyzing debt levels, the balance sheet is the obvious starting point. But it’s future earnings, more than anything, that will determine SAP’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, a business needs free cash flow to pay off its debts; book profits are not enough. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, SAP has recorded free cash flow of 81% of its EBIT, which is higher than what we would normally expect. This positions him well to pay off debt if desired.

Our point of view

Fortunately, SAP’s impressive interest coverage means it has the upper hand on its debt. But we have to admit that we are seeing its EBIT growth rate having the opposite effect. All told, it looks like SAP can comfortably handle its current level of leverage. Of course, while this leverage can improve return on equity, it comes with more risk, so it’s worth keeping an eye out for. 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. Be aware that SAP displays 1 warning sign in our investment analysis you should know…

If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.

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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