Is Honkarakenne Oyj (HEL:HONBS) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that Honkarakenne Oyj (HEL:HONBS) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Honkarakenne Oyj

How Much Debt Does Honkarakenne Oyj Carry?

As you can see below, Honkarakenne Oyj had €3.04m of debt at June 2020, down from €3.80m a year prior. But on the other hand it also has €3.70m in cash, leading to a €656.0k net cash position.

How Strong Is Honkarakenne Oyj's Balance Sheet?

We can see from the most recent balance sheet that Honkarakenne Oyj had liabilities of €12.3m falling due within a year, and liabilities of €4.40m due beyond that. Offsetting these obligations, it had cash of €3.70m as well as receivables valued at €4.80m due within 12 months. So it has liabilities totalling €8.20m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Honkarakenne Oyj has a market capitalization of €23.2m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Honkarakenne Oyj boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Honkarakenne Oyj grew its EBIT by 3.1% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is Honkarakenne Oyj's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Honkarakenne Oyj may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Honkarakenne Oyj generated free cash flow amounting to a very robust 85% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

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 €656.0k. And it impressed us with free cash flow of €45k, being 85% of its EBIT. So we don't think Honkarakenne Oyj's use of debt is risky. 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. Case in point: We've spotted 2 warning signs for Honkarakenne Oyj you should be aware of, and 1 of them is significant.

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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