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.” It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Like many other companies Ferronordic AB (publ) (STO:FNM) uses debt. But the real question is whether this debt makes the business risky.
Why is debt risky?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. If things go really bad, lenders can take over the business. However, a more usual (but still expensive) 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 look at debt levels, we first consider cash and debt levels, together.
See our latest analysis for Ferronordic
What is Ferronordic’s net debt?
You can click on the graph below for historical figures, but it shows that in March 2022, Ferronordic had a debt of 719.0 million kr, an increase from 485.7 million kr, year on year . However, he has 593.0 million kr in cash to offset this, resulting in a net debt of approximately 126.0 million kr.
How strong is Ferronordic’s balance sheet?
The latest balance sheet data shows that Ferronordic had liabilities of kr 1.79 billion falling due within one year, and liabilities of kr 550.0 million falling due thereafter. In compensation for these obligations, it had cash of 593.0 million kr as well as receivables valued at 517.0 million kr and payable within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of 1.23 billion kr.
This deficit casts a shadow over the 505.0 million kr business, like a colossus towering above mere mortals. We would therefore be watching his balance sheet closely, no doubt. Ultimately, Ferronordic would likely need a significant recapitalization if its creditors were to demand repayment.
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). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Ferronordic’s net debt is only 0.18 times its EBITDA. And its EBIT covers its interest charges 26.8 times. So we’re pretty relaxed about his super-conservative use of debt. On top of that, Ferronordic has grown its EBIT by 52% over the last twelve months, and this growth will make it easier to manage its debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is ultimately the company’s future profitability that will decide whether Ferronordic 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, a company can only repay its debts with cold hard cash, not with book profits. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Ferronordic’s free cash flow has been 29% of its EBIT, less than expected. This low cash conversion makes debt management more difficult.
Our point of view
We feel some trepidation about the difficulty level of Ferronordic’s total passive, but we also have some positives to focus on. Interest coverage and EBIT growth rate were encouraging signs. From all the angles mentioned above, it seems to us that Ferronordic is a bit risky investment because of its debt. Not all risk is bad, as it can boost stock returns if it pays off, but this leverage risk is worth keeping in mind. 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. To do this, you need to find out about the 4 warning signs we spotted some with Ferronordic (including 2 that are potentially serious).
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.
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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.