ALK-Abelló (CPH:ALK B) Has A Pretty Healthy Balance Sheet

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.' 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. Importantly, ALK-Abelló A/S (CPH:ALK B) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for ALK-Abelló

What Is ALK-Abelló's Net Debt?

As you can see below, ALK-Abelló had kr.429.0m of debt at December 2022, down from kr.466.0m a year prior. However, it does have kr.221.0m in cash offsetting this, leading to net debt of about kr.208.0m.

A Look At ALK-Abelló's Liabilities

We can see from the most recent balance sheet that ALK-Abelló had liabilities of kr.1.40b falling due within a year, and liabilities of kr.921.0m due beyond that. Offsetting this, it had kr.221.0m in cash and kr.888.0m in receivables that were due within 12 months. So it has liabilities totalling kr.1.21b more than its cash and near-term receivables, combined.

Since publicly traded ALK-Abelló shares are worth a total of kr.22.7b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. But either way, ALK-Abelló has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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).

ALK-Abelló has a low net debt to EBITDA ratio of only 0.31. And its EBIT easily covers its interest expense, being 25.1 times the size. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that ALK-Abelló has boosted its EBIT by 62%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine ALK-Abelló's ability to maintain a healthy balance sheet going forward. 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, ALK-Abelló's free cash flow amounted to 35% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

ALK-Abelló's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. Zooming out, ALK-Abelló seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. Over time, share prices tend to follow earnings per share, so if you're interested in ALK-Abelló, you may well want to click here to check an interactive graph of its earnings per share history.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.