Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to 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. We note that ASSA ABLOY AB (publisher) (STO:ASSA B) has debt on its balance sheet. But the more important question is: what risk does this debt create?
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. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first thing to do when considering how much debt a business has is to look at its cash flow and debt together.
Check out our latest analysis for ASSA ABLOY
What is ASSA ABLOY’s debt?
As you can see below, ASSA ABLOY had a debt of 25.4 billion kr, as of March 2022, roughly the same as the previous year. You can click on the graph for more details. However, he also had 4.11 billion kr in cash, so his net debt is 21.3 billion kr.
How strong is ASSA ABLOY’s balance sheet?
The latest balance sheet data shows that ASSA ABLOY had liabilities of kr 33.1 billion maturing within the year, and liabilities of kr 28.6 billion maturing thereafter. On the other hand, it had a cash position of 4.11 billion kr and 23.3 billion kr of receivables due within one year. Thus, its liabilities total kr 34.3 billion more than the combination of its cash and short-term receivables.
Given that publicly traded ASSA ABLOY shares are worth a very impressive total of kr270.9 billion, it seems unlikely that this level of liability is a major threat. That said, it is clear that we must continue to monitor its record, lest it deteriorate.
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). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
ASSA ABLOY’s net debt is only 1.2 times its EBITDA. And its EBIT covers its interest charges 22.1 times. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Additionally, we are pleased to report that ASSA ABLOY has increased its EBIT by 39%, reducing the specter of future debt repayments. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine ASSA ABLOY’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. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, ASSA ABLOY has delivered free cash flow of 84% of EBIT, which is higher than we would normally expect. This positions him well to pay off debt if desired.
Our point of view
The good news is that ASSA ABLOY’s demonstrated ability to cover its interest charges with its EBIT delights us like a fluffy puppy does a toddler. And this is only the beginning of good news since its conversion of EBIT into free cash flow is also very pleasing. Considering this set of factors, we believe that ASSA ABLOY is quite cautious with its leverage, and the risks appear to be well under control. So we are not worried about using a little leverage on the balance sheet. Another factor that would give us confidence in ASSA ABLOY would be if insiders bought shares: if you are also aware of this signal, you can find out instantly by clicking on this link.
If you are interested in investing in businesses 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.