Is SKAKO (CPH:SKAKO) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 SKAKO A/S (CPH:SKAKO) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for SKAKO

What Is SKAKO's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 SKAKO had debt of kr.76.0m, up from kr.30.7m in one year. But it also has kr.79.1m in cash to offset that, meaning it has kr.3.16m net cash.

How Healthy Is SKAKO's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that SKAKO had liabilities of kr.251.0m due within 12 months and liabilities of kr.26.0m due beyond that. On the other hand, it had cash of kr.79.1m and kr.164.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr.33.3m.

Since publicly traded SKAKO shares are worth a total of kr.243.6m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, SKAKO also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, SKAKO grew its EBIT by 37% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since SKAKO will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. SKAKO 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. Over the last three years, SKAKO recorded free cash flow worth a fulsome 94% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While SKAKO does have more liabilities than liquid assets, it also has net cash of kr.3.16m. The cherry on top was that in converted 94% of that EBIT to free cash flow, bringing in kr.34m. So is SKAKO's debt a risk? It doesn't seem so to us. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for SKAKO (of which 1 is concerning!) you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.