David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. As with many other companies Boule Diagnostics AB (publ) (STO:BOUL) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Boule Diagnostics Carry?
The image below, which you can click on for greater detail, shows that at March 2019 Boule Diagnostics had debt of kr105.2m, up from kr70.2m in one year. However, it does have kr16.8m in cash offsetting this, leading to net debt of about kr88.4m.
A Look At Boule Diagnostics's Liabilities
We can see from the most recent balance sheet that Boule Diagnostics had liabilities of kr174.4m falling due within a year, and liabilities of kr65.3m due beyond that. On the other hand, it had cash of kr16.8m and kr140.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr82.3m.
Given Boule Diagnostics has a market capitalization of kr901.9m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Boule Diagnostics's net debt to EBITDA ratio of about 1.6 suggests only moderate use of debt. And its commanding EBIT of 26.9 times its interest expense, implies the debt load is as light as a peacock feather. Importantly, Boule Diagnostics's EBIT fell a jaw-dropping 20% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Boule Diagnostics's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Considering the last three years, Boule Diagnostics actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
Boule Diagnostics's EBIT growth rate and conversion of EBIT to free cash flow definitely weigh on it, in our esteem. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. We should also note that Medical Equipment industry companies like Boule Diagnostics commonly do use debt without problems. Looking at all the angles mentioned above, it does seem to us that Boule Diagnostics is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. In light of our reservations about the company's balance sheet, it seems sensible to check if insiders have been selling shares recently.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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