Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘Volatility is far from synonymous with risk.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that OEM International AB (publ) (STO:OEM B) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.
How Much Debt Does OEM International Carry?
The image below, which you can click on for greater detail, shows that OEM International had debt of kr63.6m at the end of June 2020, a reduction from kr275.0m over a year. But it also has kr194.0m in cash to offset that, meaning it has kr130.4m net cash.
How Healthy Is OEM International’s Balance Sheet?
According to the last reported balance sheet, OEM International had liabilities of kr466.0m due within 12 months, and liabilities of kr165.0m due beyond 12 months. Offsetting these obligations, it had cash of kr194.0m as well as receivables valued at kr521.0m due within 12 months. So it actually has kr84.0m more liquid assets than total liabilities.
Having regard to OEM International’s size, it seems that its liquid assets are well balanced with its total liabilities. So while it’s hard to imagine that the kr5.78b company is struggling for cash, we still think it’s worth monitoring its balance sheet. Simply put, the fact that OEM International has more cash than debt is arguably a good indication that it can manage its debt safely.
Also good is that OEM International grew its EBIT at 12% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is OEM International’s earnings that will influence how the balance sheet holds up in the future. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. OEM International may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, OEM International produced sturdy free cash flow equating to 70% of its EBIT, about what we’d expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to investigate a company’s debt, in this case OEM International has kr130.4m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of kr361m, being 70% of its EBIT. So we don’t think OEM International’s use of debt is risky. Over time, share prices tend to follow earnings per share, so if you’re interested in OEM International, you may well want to click here to check an interactive graph of its earnings per share history.
Of course, if you’re the type of investor who prefers buying stocks without the burden of debt, then don’t hesitate to discover our exclusive list of net cash growth stocks, today.
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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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