We believe Zalaris (OB: ZAL) can stay on top of his 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 risk.” When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We note that Zalaris ASA (OB: ZAL) has debt on its balance sheet. But does this debt concern shareholders?
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we think of a business’s use of debt, we first look at cash flow and debt together.
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How much debt does Zalaris carry?
You can click on the graph below for historical figures, but it shows Zalaris owed kr 366.9million in June 2021, up from kr 408.0million a year earlier. On the other hand, he has 212.0 million kr in cash, resulting in a net debt of around 154.9 million kr.
How healthy is Zalaris’ track record?
According to the latest published balance sheet, Zalaris had debts of Kroner 200.4 million due within 12 months and Kroner 398.0 million debts due beyond 12 months. On the other hand, he had cash of 212.0 million kr and 168.6 million kr in receivables due within one year. Its liabilities therefore total 217.8 million kr more than the combination of its cash and short-term receivables.
Considering that Zalaris has a market capitalization of 1.25 billion crowns, it is hard to believe that these liabilities pose a significant threat. However, we think it’s worth keeping an eye on the strength of its balance sheet as it can change over time.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
While Zalaris’ debt to EBITDA ratio (3.1) suggests that he is using some debt, his interest coverage is very low, at 1.5, which suggests high leverage. It seems clear that the cost of borrowing money is having a negative impact on shareholder returns lately. Looking on the bright side, Zalaris has increased its EBIT by a silky 70% over the past year. Like a mother’s loving embrace of a newborn, this type of growth builds resilience, putting the business in a stronger position to manage debt. There is no doubt that we learn the most about debt from the balance sheet. But you can’t look at debt in isolation; since Zalaris will need income to repay this debt. So, when considering debt, it is really worth looking at the profit trend. Click here for an interactive snapshot.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Fortunately for all shareholders, Zalaris has actually generated more free cash flow than EBIT over the past three years. This kind of strong cash generation warms our hearts like a puppy in a bumblebee costume.
Our point of view
Zalaris’ conversion of EBIT to free cash flow suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. But the hard truth is that we are concerned about its coverage of interest. Considering all of this data, it seems to us that Zalaris is taking a pretty sane approach to debt. This means that they are taking a bit more risk, in the hope of increasing returns for shareholders. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. For example, we discovered 4 warning signs for Zalaris (2 shouldn’t be ignored!) Which you should be aware of before investing here.
If you are interested in investing in companies that can generate profits without the burden of debt, check out this page free list of growing companies that have net cash on the balance sheet.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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