Here's Why UPM-Kymmene Oyj (HEL:UPM) Can Manage Its Debt Responsibly

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 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. Importantly, UPM-Kymmene Oyj (HEL:UPM) does carry debt. 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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. 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 UPM-Kymmene Oyj

How Much Debt Does UPM-Kymmene Oyj Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 UPM-Kymmene Oyj had €2.80b of debt, an increase on €2.63b, over one year. However, because it has a cash reserve of €1.34b, its net debt is less, at about €1.46b.

A Look At UPM-Kymmene Oyj's Liabilities

According to the last reported balance sheet, UPM-Kymmene Oyj had liabilities of €2.98b due within 12 months, and liabilities of €4.00b due beyond 12 months. Offsetting this, it had €1.34b in cash and €2.08b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €3.56b.

This deficit isn't so bad because UPM-Kymmene Oyj is worth a massive €17.4b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

UPM-Kymmene Oyj has a low net debt to EBITDA ratio of only 0.89. And its EBIT easily covers its interest expense, being 92.9 times the size. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that UPM-Kymmene Oyj has boosted its EBIT by 43%, thus reducing the spectre of future debt repayments. 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 UPM-Kymmene 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, UPM-Kymmene Oyj recorded free cash flow of 22% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

UPM-Kymmene 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, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. When we consider the range of factors above, it looks like UPM-Kymmene Oyj is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for UPM-Kymmene Oyj you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.