Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk. 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 Axfood AB (publ) (STO:AXFO) makes use of debt. But the more important question is: how much risk is that debt creating?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Axfood Carry?
You can click the graphic below for the historical numbers, but it shows that Axfood had kr422.0m of debt in June 2019, down from kr531.0m, one year before. However, its balance sheet shows it holds kr738.0m in cash, so it actually has kr316.0m net cash.
A Look At Axfood's Liabilities
According to the last reported balance sheet, Axfood had liabilities of kr8.00b due within 12 months, and liabilities of kr5.61b due beyond 12 months. Offsetting these obligations, it had cash of kr738.0m as well as receivables valued at kr1.21b due within 12 months. So it has liabilities totalling kr11.7b more than its cash and near-term receivables, combined.
Axfood has a market capitalization of kr42.7b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Axfood boasts net cash, so it's fair to say it does not have a heavy debt load!
Fortunately, Axfood grew its EBIT by 8.2% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Axfood can strengthen its balance sheet over time. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Axfood 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, Axfood generated free cash flow amounting to a very robust 98% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
While Axfood does have more liabilities than liquid assets, it also has net cash of kr316.0m. The cherry on top was that in converted 98% of that EBIT to free cash flow, bringing in kr2.4b. So we don't think Axfood's use of debt is risky. Given Axfood has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
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.
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