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 Nilörngruppen AB (STO:NIL B) makes use of debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is Nilörngruppen's Net Debt?
As you can see below, at the end of June 2019, Nilörngruppen had kr103.5m of debt, up from kr71.4m a year ago. Click the image for more detail. However, it also had kr50.9m in cash, and so its net debt is kr52.6m.
How Healthy Is Nilörngruppen's Balance Sheet?
The latest balance sheet data shows that Nilörngruppen had liabilities of kr211.7m due within a year, and liabilities of kr72.0m falling due after that. Offsetting these obligations, it had cash of kr50.9m as well as receivables valued at kr82.6m due within 12 months. So its liabilities total kr150.1m more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Nilörngruppen has a market capitalization of kr647.6m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Nilörngruppen has a low net debt to EBITDA ratio of only 0.61. And its EBIT covers its interest expense a whopping 117 times over. So we're pretty relaxed about its super-conservative use of debt. On the other hand, Nilörngruppen saw its EBIT drop by 3.5% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Nilörngruppen 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 company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Nilörngruppen recorded free cash flow of 44% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
When it comes to the balance sheet, the standout positive for Nilörngruppen was the fact that it seems able to cover its interest expense with its EBIT confidently. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to grow its EBIT. Considering this range of data points, we think Nilörngruppen is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Nilörngruppen's dividend history, without delay!
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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