Is Lassila & Tikanoja Oyj (HEL:LAT1V) 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. As with many other companies Lassila & Tikanoja Oyj (HEL:LAT1V) makes use of debt. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Lassila & Tikanoja Oyj

What Is Lassila & Tikanoja Oyj's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Lassila & Tikanoja Oyj had debt of €114.7m, up from €100.5m in one year. However, it does have €50.2m in cash offsetting this, leading to net debt of about €64.5m.

How Healthy Is Lassila & Tikanoja Oyj's Balance Sheet?

The latest balance sheet data shows that Lassila & Tikanoja Oyj had liabilities of €211.8m due within a year, and liabilities of €192.2m falling due after that. Offsetting these obligations, it had cash of €50.2m as well as receivables valued at €116.3m due within 12 months. So it has liabilities totalling €237.5m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Lassila & Tikanoja Oyj has a market capitalization of €542.6m, 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 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Lassila & Tikanoja Oyj has net debt of just 0.95 times EBITDA, indicating that it is certainly not a reckless borrower. And this view is supported by the solid interest coverage, with EBIT coming in at 8.1 times the interest expense over the last year. The modesty of its debt load may become crucial for Lassila & Tikanoja Oyj if management cannot prevent a repeat of the 22% 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. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Lassila & Tikanoja Oyj can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Lassila & Tikanoja Oyj actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Based on what we've seen Lassila & Tikanoja Oyj is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to convert EBIT to free cash flow is pretty flash. When we consider all the factors mentioned above, we do feel a bit cautious about Lassila & Tikanoja Oyj's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. To that end, you should be aware of the 3 warning signs we've spotted with Lassila & Tikanoja Oyj .

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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