Here's Why Elecster Oyj (HEL:ELEAV) Has A Meaningful Debt Burden

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 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, Elecster Oyj (HEL:ELEAV) does carry debt. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

See our latest analysis for Elecster Oyj

What Is Elecster Oyj's Net Debt?

As you can see below, Elecster Oyj had €11.7m of debt at December 2021, down from €17.4m a year prior. However, because it has a cash reserve of €10.4m, its net debt is less, at about €1.26m.

How Healthy Is Elecster Oyj's Balance Sheet?

The latest balance sheet data shows that Elecster Oyj had liabilities of €10.3m due within a year, and liabilities of €11.9m falling due after that. Offsetting this, it had €10.4m in cash and €7.12m in receivables that were due within 12 months. So its liabilities total €4.74m more than the combination of its cash and short-term receivables.

Given Elecster Oyj has a market capitalization of €27.4m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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

Elecster Oyj has a very low debt to EBITDA ratio of 0.60 so it is strange to see weak interest coverage, with last year's EBIT being only 0.55 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. Importantly, Elecster Oyj's EBIT fell a jaw-dropping 94% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Elecster Oyj 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, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Elecster Oyj produced sturdy free cash flow equating to 62% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

While Elecster Oyj's interest cover makes us cautious about it, its track record of (not) growing its EBIT is no better. But at least its net debt to EBITDA is a gleaming silver lining to those clouds. We think that Elecster 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. To that end, you should learn about the 3 warning signs we've spotted with Elecster Oyj (including 1 which is a bit concerning) .

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.