These 4 Measures Indicate That Rockwool (CPH:ROCK B) Is Using Debt Safely

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Rockwool A/S (CPH:ROCK B) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Rockwool

What Is Rockwool's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Rockwool had €38.0m of debt in December 2023, down from €148.0m, one year before. But it also has €354.0m in cash to offset that, meaning it has €316.0m net cash.

How Strong Is Rockwool's Balance Sheet?

According to the last reported balance sheet, Rockwool had liabilities of €551.0m due within 12 months, and liabilities of €199.0m due beyond 12 months. On the other hand, it had cash of €354.0m and €434.0m worth of receivables due within a year. So it can boast €38.0m more liquid assets than total liabilities.

Having regard to Rockwool's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the €6.50b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Rockwool boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Rockwool grew its EBIT by 33% over the last twelve months, and that growth will make it easier to handle its debt. 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 Rockwool's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Rockwool 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. In the last three years, Rockwool's free cash flow amounted to 42% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Rockwool has net cash of €316.0m, as well as more liquid assets than liabilities. And we liked the look of last year's 33% year-on-year EBIT growth. So is Rockwool's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Rockwool has 1 warning sign we think you should be aware of.

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.