Is H+H International (CPH:HH) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 H+H International A/S (CPH:HH) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for H+H International

How Much Debt Does H+H International Carry?

As you can see below, at the end of December 2022, H+H International had kr.920.0m of debt, up from kr.743.0m a year ago. Click the image for more detail. However, because it has a cash reserve of kr.536.0m, its net debt is less, at about kr.384.0m.

A Look At H+H International's Liabilities

According to the last reported balance sheet, H+H International had liabilities of kr.535.0m due within 12 months, and liabilities of kr.1.28b due beyond 12 months. On the other hand, it had cash of kr.536.0m and kr.162.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr.1.11b.

This deficit is considerable relative to its market capitalization of kr.1.83b, so it does suggest shareholders should keep an eye on H+H International's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

H+H International's net debt is only 0.63 times its EBITDA. And its EBIT covers its interest expense a whopping 43.6 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The good news is that H+H International has increased its EBIT by 9.3% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if H+H International 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 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, H+H International produced sturdy free cash flow equating to 51% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

When it comes to the balance sheet, the standout positive for H+H International was the fact that it seems able to cover its interest expense with its EBIT confidently. But the other factors we noted above weren't so encouraging. For example, its level of total liabilities makes us a little nervous about its debt. Considering this range of data points, we think H+H International is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of H+H International's earnings per share history for free.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.