Honkarakenne Oyj (HEL:HONBS) Seems To Use Debt Rather Sparingly

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 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. We can see that Honkarakenne Oyj (HEL:HONBS) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Honkarakenne Oyj

What Is Honkarakenne Oyj's Net Debt?

As you can see below, Honkarakenne Oyj had €3.40m of debt at June 2021, down from €4.90m a year prior. However, its balance sheet shows it holds €13.0m in cash, so it actually has €9.60m net cash.

How Strong Is Honkarakenne Oyj's Balance Sheet?

According to the last reported balance sheet, Honkarakenne Oyj had liabilities of €25.6m due within 12 months, and liabilities of €3.20m due beyond 12 months. On the other hand, it had cash of €13.0m and €8.10m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €7.70m.

While this might seem like a lot, it is not so bad since Honkarakenne Oyj has a market capitalization of €35.3m, 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. Despite its noteworthy liabilities, Honkarakenne Oyj boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Honkarakenne Oyj grew its EBIT by 17% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Honkarakenne 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Honkarakenne 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 last three years, Honkarakenne Oyj actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

Although Honkarakenne Oyj's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €9.60m. And it impressed us with free cash flow of €10m, being 137% of its EBIT. So is Honkarakenne Oyj's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Honkarakenne Oyj is showing 3 warning signs in our investment analysis , you should know about...

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.
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