Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Lassila & Tikanoja Oyj (HEL:LAT1V) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. 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.
What Is Lassila & Tikanoja Oyj's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Lassila & Tikanoja Oyj had €127.5m of debt in June 2019, down from €166.9m, one year before. However, it also had €44.9m in cash, and so its net debt is €82.6m.
How Strong Is Lassila & Tikanoja Oyj's Balance Sheet?
According to the last reported balance sheet, Lassila & Tikanoja Oyj had liabilities of €216.3m due within 12 months, and liabilities of €194.2m due beyond 12 months. Offsetting this, it had €44.9m in cash and €134.0m in receivables that were due within 12 months. So its liabilities total €231.6m more than the combination of its cash and short-term receivables.
Lassila & Tikanoja Oyj has a market capitalization of €502.5m, 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.
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).
Lassila & Tikanoja Oyj's net debt is only 1.0 times its EBITDA. And its EBIT covers its interest expense a whopping 29.2 times over. So we're pretty relaxed about its super-conservative use of debt. On the other hand, Lassila & Tikanoja Oyj saw its EBIT drop by 6.6% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Lassila & Tikanoja Oyj'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, Lassila & Tikanoja Oyj actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
The good news is that Lassila & Tikanoja Oyj's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its EBIT growth rate does undermine this impression a bit. Looking at all the aforementioned factors together, it strikes us that Lassila & Tikanoja Oyj can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Lassila & Tikanoja Oyj's dividend history, without delay!
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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