Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Nokia Corporation (HEL:NOKIA) does use debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Nokia Carry?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 Nokia had €5.76b of debt, an increase on €4.48b, over one year. However, its balance sheet shows it holds €7.88b in cash, so it actually has €2.12b net cash.
How Strong Is Nokia's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Nokia had liabilities of €11.4b due within 12 months and liabilities of €12.2b due beyond that. Offsetting these obligations, it had cash of €7.88b as well as receivables valued at €5.86b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €9.85b.
This deficit is considerable relative to its very significant market capitalization of €15.8b, so it does suggest shareholders should keep an eye on Nokia's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Nokia boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that Nokia has boosted its EBIT by 79%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Nokia can strengthen its balance sheet over time. 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. Nokia 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. In the last three years, Nokia's free cash flow amounted to 47% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Although Nokia's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €2.12b. And we liked the look of last year's 79% year-on-year EBIT growth. So we don't have any problem with Nokia's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Nokia that you should be aware of before investing here.
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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