Here's Why Neste Oyj (HEL:NESTE) Can Manage Its Debt Responsibly

By
Simply Wall St
Published
January 18, 2022
HLSE:NESTE
Source: Shutterstock

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Neste Oyj (HEL:NESTE) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Neste Oyj

What Is Neste Oyj's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2021 Neste Oyj had debt of €1.50b, up from €886.0m in one year. However, because it has a cash reserve of €1.49b, its net debt is less, at about €11.0m.

debt-equity-history-analysis
HLSE:NESTE Debt to Equity History January 18th 2022

How Healthy Is Neste Oyj's Balance Sheet?

The latest balance sheet data shows that Neste Oyj had liabilities of €3.30b due within a year, and liabilities of €1.94b falling due after that. Offsetting these obligations, it had cash of €1.49b as well as receivables valued at €1.55b due within 12 months. So its liabilities total €2.20b more than the combination of its cash and short-term receivables.

Since publicly traded Neste Oyj shares are worth a very impressive total of €34.1b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Carrying virtually no net debt, Neste Oyj has a very light debt load indeed.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With debt at a measly 0.0052 times EBITDA and EBIT covering interest a whopping 40.2 times, it's clear that Neste Oyj is not a desperate borrower. Indeed relative to its earnings its debt load seems light as a feather. On the other hand, Neste Oyj saw its EBIT drop by 7.0% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Neste 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Neste Oyj recorded free cash flow worth 52% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Neste Oyj's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its EBIT growth rate does undermine this impression a bit. All these things considered, it appears that Neste Oyj can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. Over time, share prices tend to follow earnings per share, so if you're interested in Neste Oyj, you may well want to click here to check an interactive graph of its earnings per share history.

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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