Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Like many other companies Saab AB (publisher) (STO: SAAB B) uses debt. But does this debt worry shareholders?

When is debt dangerous?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. If things go really bad, lenders can take over the business. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. 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 analysis for Saab

What is Saab’s debt?

As you can see below, Saab had a debt of 7.22 billion kr in December 2021, compared to 7.56 billion kr the previous year. But on the other hand, he also has 11.9 billion kr in cash which leads to a net cash position of 4.66 billion kr.

A look at Saab’s responsibilities

According to the latest published balance sheet, Saab had liabilities of kr 25.3 billion maturing within 12 months and liabilities of kr 16.5 billion maturing beyond 12 months. In return, he had 11.9 billion kr in cash and 16.3 billion kr in debt due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of 13.6 billion kr.

Saab has a market capitalization of 46.1 billion kr, so it could very likely raise funds to improve its balance sheet, should the need arise. However, it is always worth taking a close look at its ability to repay debt. While it has liabilities to note, Saab also has more cash than debt, so we’re pretty confident it can manage its debt safely.

What is even more impressive is that Saab increased its EBIT by 197% year-over-year. 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 it is future earnings, more than anything, that will determine Saab’s ability to maintain a healthy balance sheet in the future. 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. Although Saab has net cash on its balance sheet, it’s always worth looking at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how fast it’s building (or erodes) this cash balance. Over the past three years, Saab has recorded free cash flow of 68% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This cold hard cash allows him to reduce his debt whenever he wants.

Abstract

Although Saab has more liabilities than liquid assets, it also has a net cash position of 4.66 billion kr. And it has impressed us with its 197% EBIT growth over the past year. We therefore do not believe that Saab’s use of debt is risky. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example – Saab has 3 warning signs we think you should know.

Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.

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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.