Is Nokian Renkaat Oyj (HEL:TYRES) Using Too Much Debt?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Nokian Renkaat Oyj (HEL:TYRES) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Nokian Renkaat Oyj

How Much Debt Does Nokian Renkaat Oyj Carry?

As you can see below, at the end of September 2023, Nokian Renkaat Oyj had €508.4m of debt, up from €354.4m a year ago. Click the image for more detail. However, it does have €248.1m in cash offsetting this, leading to net debt of about €260.3m.

How Healthy Is Nokian Renkaat Oyj's Balance Sheet?

According to the last reported balance sheet, Nokian Renkaat Oyj had liabilities of €410.7m due within 12 months, and liabilities of €498.9m due beyond 12 months. Offsetting these obligations, it had cash of €248.1m as well as receivables valued at €463.1m due within 12 months. So it has liabilities totalling €198.4m more than its cash and near-term receivables, combined.

Since publicly traded Nokian Renkaat Oyj shares are worth a total of €1.15b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With debt at a measly -2.7 times EBITDA and EBIT covering interest a whopping 10.3 times, it's clear that Nokian Renkaat Oyj is not a desperate borrower. Indeed relative to its earnings its debt load seems light as a feather. In fact Nokian Renkaat Oyj's saving grace is its low debt levels, because its EBIT has tanked 21% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Nokian Renkaat Oyj can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Nokian Renkaat Oyj recorded free cash flow of 32% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

We feel some trepidation about Nokian Renkaat Oyj's difficulty EBIT growth rate, but we've got positives to focus on, too. To wit both its net debt to EBITDA and interest cover were encouraging signs. We think that Nokian Renkaat Oyj's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Nokian Renkaat Oyj (1 is significant!) that you should be aware of before investing here.

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.