Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Olvi Oyj (HEL:OLVAS) does use debt in its business. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Olvi Oyj's Net Debt?
The image below, which you can click on for greater detail, shows that at September 2021 Olvi Oyj had debt of €11.5m, up from €2.38m in one year. However, it does have €70.1m in cash offsetting this, leading to net cash of €58.6m.
A Look At Olvi Oyj's Liabilities
According to the last reported balance sheet, Olvi Oyj had liabilities of €173.0m due within 12 months, and liabilities of €26.0m due beyond 12 months. Offsetting these obligations, it had cash of €70.1m as well as receivables valued at €93.9m due within 12 months. So its liabilities total €35.0m more than the combination of its cash and short-term receivables.
Since publicly traded Olvi Oyj shares are worth a total of €981.8m, 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. While it does have liabilities worth noting, Olvi Oyj also has more cash than debt, so we're pretty confident it can manage its debt safely.
The good news is that Olvi Oyj has increased its EBIT by 2.9% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Olvi Oyj's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Olvi 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 most recent three years, Olvi Oyj recorded free cash flow worth 78% 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.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Olvi Oyj has €58.6m in net cash. And it impressed us with free cash flow of €72m, being 78% of its EBIT. So we don't think Olvi Oyj's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Olvi Oyj, you may well want to click here to check an interactive graph of its earnings per share history.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.