We Think Ambu (CPH:AMBU B) Is Taking Some Risk With Its Debt

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.' 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 Ambu A/S (CPH:AMBU B) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Ambu

What Is Ambu's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Ambu had kr.985.0m of debt, an increase on kr.406.0m, over one year. On the flip side, it has kr.112.0m in cash leading to net debt of about kr.873.0m.

How Strong Is Ambu's Balance Sheet?

The latest balance sheet data shows that Ambu had liabilities of kr.864.0m due within a year, and liabilities of kr.1.53b falling due after that. On the other hand, it had cash of kr.112.0m and kr.739.0m worth of receivables due within a year. So it has liabilities totalling kr.1.54b more than its cash and near-term receivables, combined.

Given Ambu has a market capitalization of kr.18.7b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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.

With net debt to EBITDA of 2.7 Ambu has a fairly noticeable amount of debt. But the high interest coverage of 8.1 suggests it can easily service that debt. Importantly, Ambu's EBIT fell a jaw-dropping 58% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Ambu 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. During the last three years, Ambu burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Ambu's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its interest cover is a good sign, and makes us more optimistic. We should also note that Medical Equipment industry companies like Ambu commonly do use debt without problems. Once we consider all the factors above, together, it seems to us that Ambu's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - Ambu has 2 warning signs we think you should be aware of.

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.