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 may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Like many other companies ALK-Abelló A/S (CPH:ALK B) uses debt. But the real question is whether this debt makes the business risky.
When is debt dangerous?
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. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.
See our latest analysis for ALK-Abelló
What is ALK-Abelló’s debt?
As you can see below, ALK-Abelló had a debt of 466.0 million kr in December 2021, compared to 704.0 million kr the previous year. On the other hand, he has 194.0 million kr in cash, resulting in a net debt of around 272.0 million kr.
A look at ALK-Abelló’s responsibilities
According to the latest published balance sheet, ALK-Abelló had liabilities of kr 1.39 billion due within 12 months and liabilities of kr 965.0 million due beyond 12 months. On the other hand, it had cash of 194.0 million kr and receivables worth 691.0 million kr within one year. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of 1.47 billion kr.
Given that ALK-Abelló has a market capitalization of 29.5 billion kr, it is hard to believe that these liabilities pose a big threat. However, we think it’s worth keeping an eye on the strength of its balance sheet, as it can change over time. But anyway, ALK-Abelló has hardly any net debt, so it’s fair to say that it doesn’t have a lot of debt!
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). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
ALK-Abelló has a low net debt to EBITDA ratio of just 0.59. And its EBIT covers its interest charges 14.1 times. So we’re pretty relaxed about his super-conservative use of debt. On top of that, we are pleased to report that ALK-Abelló increased its EBIT by 79%, reducing the specter of future debt repayments. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine ALK-Abelló’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, a company can only repay its debts with cold hard cash, not with book profits. We therefore always check how much of this EBIT is converted into free cash flow. Over the past two years, ALK-Abelló has recorded free cash flow of 59% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
ALK-Abelló’s interest coverage suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. And the good news does not stop there, since its EBIT growth rate also confirms this impression! Given this range of factors, it seems to us that ALK-Abelló is quite cautious with its debt, and the risks seem well contained. The balance sheet therefore seems rather healthy to us. Over time, stock prices tend to track earnings per share, so if you’re interested in ALK-Abelló, you may want to click here to view an interactive chart of its earnings per share history.
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.