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 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. We can see that OKEA ASA (OB:OKEA) uses debt in its business. But should shareholders worry about its use of debt?
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. If things go really bad, lenders can take over the business. 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, debt can be an important tool in businesses, especially capital-intensive businesses. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for OKEA
What is OKEA’s net debt?
The image below, which you can click on for more details, shows that OKEA had a debt of 2.38 billion kr at the end of September 2021, a reduction from 2.69 billion kr year-on-year. However, he also had 1.50 billion kr in cash, so his net debt is 875.7 million kr.
How healthy is OKEA’s balance sheet?
Zooming in on the latest balance sheet data, we can see that OKEA had liabilities of 1.28 billion kr due within 12 months and liabilities of 8.48 billion kr due beyond. In return, he had 1.50 billion kr in cash and 704.5 million kr in debt due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of 7.55 billion kr.
The deficiency here weighs heavily on the kr3.03b business itself, like a child struggling under the weight of a huge backpack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. Ultimately, OKEA would likely need a major recapitalization if its creditors were to demand repayment.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
OKEA’s net debt is only 0.38 times its EBITDA. And its EBIT covers its interest charges 12.3 times. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. What is even more impressive is that OKEA increased its EBIT by 479% year-over-year. This boost will make paying off debt even easier in the future. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether OKEA can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, while the taxman may love accounting profits, lenders only accept cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, OKEA has generated free cash flow of a very strong 95% of its EBIT, more than we expected. This positions him well to pay off debt if desired.
Our point of view
Based on what we’ve seen, OKEA doesn’t find it easy, given its level of total liabilities, but the other factors we’ve considered give us cause for optimism. There is no doubt that its ability to cover its interest costs with its EBIT is quite flashy. Given this range of data points, we believe OKEA is in a good position to manage its level of leverage. That said, the charge is heavy enough that we recommend that any shareholder keep a close eye on it. 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. Be aware that OKEA displays 3 warning signs in our investment analysis , and 1 of them does not suit us too much…
If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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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.
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