These 4 Measures Indicate That Incap Oyj (HEL:ICP1V) Is Using Debt Reasonably Well

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 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. As with many other companies Incap Oyj (HEL:ICP1V) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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, 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 Incap Oyj

What Is Incap Oyj's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Incap Oyj had €4.98m of debt, an increase on €3.12m, over one year. On the flip side, it has €3.90m in cash leading to net debt of about €1.08m.

How Healthy Is Incap Oyj's Balance Sheet?

We can see from the most recent balance sheet that Incap Oyj had liabilities of €29.2m falling due within a year, and liabilities of €8.60m due beyond that. On the other hand, it had cash of €3.90m and €21.3m worth of receivables due within a year. So its liabilities total €12.6m more than the combination of its cash and short-term receivables.

Given Incap Oyj has a market capitalization of €125.1m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Carrying virtually no net debt, Incap Oyj has a very light debt load indeed.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With debt at a measly 0.074 times EBITDA and EBIT covering interest a whopping 21.9 times, it's clear that Incap Oyj is not a desperate borrower. Indeed relative to its earnings its debt load seems light as a feather. Also positive, Incap Oyj grew its EBIT by 25% in the last year, and that should make it easier to pay down debt, going forward. 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 Incap 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 company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Incap Oyj's free cash flow amounted to 32% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Incap 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. Zooming out, Incap Oyj seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Incap Oyj is showing 3 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...

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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This article by Simply Wall St is general in nature. 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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