Aktieselskabet Schouw (CPH:SCHO) Has A Somewhat Strained Balance Sheet

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Aktieselskabet Schouw & Co. (CPH:SCHO) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Aktieselskabet Schouw

How Much Debt Does Aktieselskabet Schouw Carry?

The chart below, which you can click on for greater detail, shows that Aktieselskabet Schouw had kr.6.89b in debt in June 2024; about the same as the year before. However, it does have kr.777.0m in cash offsetting this, leading to net debt of about kr.6.12b.

A Look At Aktieselskabet Schouw's Liabilities

We can see from the most recent balance sheet that Aktieselskabet Schouw had liabilities of kr.11.1b falling due within a year, and liabilities of kr.6.02b due beyond that. On the other hand, it had cash of kr.777.0m and kr.7.35b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr.8.99b.

This deficit is considerable relative to its market capitalization of kr.13.6b, so it does suggest shareholders should keep an eye on Aktieselskabet Schouw's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Aktieselskabet Schouw has net debt worth 2.2 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 4.5 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Also relevant is that Aktieselskabet Schouw has grown its EBIT by a very respectable 30% in the last year, thus enhancing its ability to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Aktieselskabet Schouw can strengthen its balance sheet over time. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Aktieselskabet Schouw created free cash flow amounting to 4.0% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Aktieselskabet Schouw's conversion of EBIT to free cash flow and level of total liabilities definitely weigh on it, in our esteem. But its EBIT growth rate tells a very different story, and suggests some resilience. Looking at all the angles mentioned above, it does seem to us that Aktieselskabet Schouw is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Aktieselskabet Schouw is showing 1 warning sign in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.