Grieg Seafood (OB:GSF) could easily take on more debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Like many other companies Grieg Seafood ASA (OB:GSF) uses debt. But should shareholders worry about its use of debt?

Why is debt risky?

Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, many companies use debt to finance their growth, without any negative consequences. The first thing to do when considering how much debt a business has is to look at its cash and debt together.

See our latest review for Grieg Seafood

What is Grieg Seafood’s net debt?

As you can see below, Grieg Seafood had 3.05 billion kr in debt in March 2022, compared to 4.12 billion kr the previous year. However, he also had 1.71 billion kr in cash, so his net debt is 1.34 billion kr.

OB:GSF Debt to Equity Historical June 21, 2022

How strong is Grieg Seafood’s balance sheet?

According to the latest published balance sheet, Grieg Seafood had liabilities of kr 1.33 billion maturing within 12 months and liabilities of kr 4.77 billion maturing beyond 12 months. On the other hand, it had cash of 1.71 billion kr and 415.8 million kr of receivables due within one year. Thus, its liabilities total kr 3.98 billion more than the combination of its cash and short-term receivables.

While that might sound like a lot, it’s not too bad since Grieg Seafood has a market cap of 15.9 billion kr, so it could probably strengthen its balance sheet by raising capital if needed. However, it is always worth taking a close look at its ability to repay debt.

We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).

Grieg Seafood has net debt of just 0.70 times EBITDA, indicating that he is certainly not an imprudent borrower. And it has interest coverage of 8.7 times, which is more than enough. Even better, Grieg Seafood increased its EBIT by 343% last year, which is an impressive improvement. If sustained, this growth will make debt even more manageable in years to come. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Grieg Seafood can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

Finally, while the taxman may love accounting profits, lenders only accept cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Grieg Seafood has recorded free cash flow of 97% 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, Grieg Seafood’s impressive EBIT to free cash flow conversion means it has the upper hand on its debt. And this is only the beginning of good news since its EBIT growth rate is also very encouraging. Zooming out, Grieg Seafood appears to be using debt quite sensibly; and that gets the green light from us. Although debt carries risks, when used wisely, it can also generate a higher return on equity. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we have identified 2 warning signs for Grieg Seafood (1 is concerning) that you should be aware of.

In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.

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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