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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Københavns Lufthavne A/S (CPH:KBHL) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.
How Much Debt Does Københavns Lufthavne Carry?
You can click the graphic below for the historical numbers, but it shows that Københavns Lufthavne had kr.9.98b of debt in June 2023, down from kr.10.6b, one year before. Net debt is about the same, since the it doesn't have much cash.
How Strong Is Københavns Lufthavne's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Københavns Lufthavne had liabilities of kr.7.12b due within 12 months and liabilities of kr.4.98b due beyond that. Offsetting this, it had kr.91.0m in cash and kr.494.0m in receivables that were due within 12 months. So its liabilities total kr.11.5b more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Københavns Lufthavne has a market capitalization of kr.38.6b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
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). 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).
Københavns Lufthavne has a rather high debt to EBITDA ratio of 6.5 which suggests a meaningful debt load. However, its interest coverage of 3.0 is reasonably strong, which is a good sign. However, it should be some comfort for shareholders to recall that Københavns Lufthavne actually grew its EBIT by a hefty 872%, over the last 12 months. If it can keep walking that path it will be in a position to shed its debt with relative ease. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Københavns Lufthavne will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Københavns Lufthavne actually produced more free cash flow than EBIT over the last two years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Københavns Lufthavne's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its net debt to EBITDA has the opposite effect. We would also note that Infrastructure industry companies like Københavns Lufthavne commonly do use debt without problems. All these things considered, it appears that Københavns Lufthavne can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Københavns Lufthavne , and understanding them should be part of your investment process.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.