Does Nilfisk Holding (CPH:NLFSK) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Nilfisk Holding A/S (CPH:NLFSK) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, 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 capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Nilfisk Holding

How Much Debt Does Nilfisk Holding Carry?

As you can see below, Nilfisk Holding had €298.5m of debt at December 2021, down from €332.5m a year prior. However, because it has a cash reserve of €15.0m, its net debt is less, at about €283.5m.

How Healthy Is Nilfisk Holding's Balance Sheet?

We can see from the most recent balance sheet that Nilfisk Holding had liabilities of €286.8m falling due within a year, and liabilities of €346.7m due beyond that. Offsetting this, it had €15.0m in cash and €198.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €420.0m.

While this might seem like a lot, it is not so bad since Nilfisk Holding has a market capitalization of €781.6m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Nilfisk Holding has a debt to EBITDA ratio of 2.8, which signals significant debt, but is still pretty reasonable for most types of business. However, its interest coverage of 10.0 is very high, suggesting that the interest expense on the debt is currently quite low. Pleasingly, Nilfisk Holding is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 172% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Nilfisk Holding's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Nilfisk Holding generated free cash flow amounting to a very robust 96% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

The good news is that Nilfisk Holding's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But truth be told we feel its net debt to EBITDA does undermine this impression a bit. When we consider the range of factors above, it looks like Nilfisk Holding is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Nilfisk Holding that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.