These 4 Measures Indicate That Nokian Renkaat Oyj (HEL:TYRES) Is Using Debt Reasonably Well

By
Simply Wall St
Published
July 14, 2021
HLSE:TYRES
Source: Shutterstock

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.' 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. Importantly, Nokian Renkaat Oyj (HEL:TYRES) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Nokian Renkaat Oyj

What Is Nokian Renkaat Oyj's Debt?

You can click the graphic below for the historical numbers, but it shows that Nokian Renkaat Oyj had €292.0m of debt in March 2021, down from €339.5m, one year before. But it also has €410.4m in cash to offset that, meaning it has €118.4m net cash.

debt-equity-history-analysis
HLSE:TYRES Debt to Equity History July 14th 2021

How Strong Is Nokian Renkaat Oyj's Balance Sheet?

We can see from the most recent balance sheet that Nokian Renkaat Oyj had liabilities of €514.4m falling due within a year, and liabilities of €277.6m due beyond that. Offsetting these obligations, it had cash of €410.4m as well as receivables valued at €486.7m due within 12 months. So it can boast €105.1m more liquid assets than total liabilities.

This short term liquidity is a sign that Nokian Renkaat Oyj could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Nokian Renkaat Oyj has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Nokian Renkaat Oyj if management cannot prevent a repeat of the 34% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Nokian Renkaat Oyj'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. While Nokian Renkaat Oyj has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Nokian Renkaat Oyj recorded free cash flow worth 62% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case Nokian Renkaat Oyj has €118.4m in net cash and a decent-looking balance sheet. So we don't have any problem with Nokian Renkaat Oyj's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Nokian Renkaat Oyj is showing 2 warning signs in our investment analysis , you should know about...

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.

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