These 4 Measures Indicate That Silkeborg IF Invest (CPH:SIF) Is Using Debt In A Risky Way

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Silkeborg IF Invest A/S (CPH:SIF) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Silkeborg IF Invest

How Much Debt Does Silkeborg IF Invest Carry?

The image below, which you can click on for greater detail, shows that Silkeborg IF Invest had debt of kr.312.7m at the end of June 2022, a reduction from kr.327.4m over a year. However, it also had kr.10.0m in cash, and so its net debt is kr.302.7m.

How Strong Is Silkeborg IF Invest's Balance Sheet?

According to the last reported balance sheet, Silkeborg IF Invest had liabilities of kr.38.7m due within 12 months, and liabilities of kr.341.9m due beyond 12 months. Offsetting these obligations, it had cash of kr.10.0m as well as receivables valued at kr.5.59m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr.365.0m.

This deficit casts a shadow over the kr.202.0m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Silkeborg IF Invest would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 2.3 times and a disturbingly high net debt to EBITDA ratio of 11.8 hit our confidence in Silkeborg IF Invest like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, Silkeborg IF Invest saw its EBIT tank 21% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Silkeborg IF Invest 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Silkeborg IF Invest reported free cash flow worth 4.4% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

On the face of it, Silkeborg IF Invest's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its interest cover also fails to instill confidence. We think the chances that Silkeborg IF Invest has too much debt a very significant. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. 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, we've discovered 4 warning signs for Silkeborg IF Invest (1 is significant!) that you should be aware of before investing here.

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.