Here's Why Ericsson Nikola Tesla d.d (ZGSE:ERNT) Can Manage Its Debt Responsibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that Ericsson Nikola Tesla d.d. (ZGSE:ERNT) does use debt in its business. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Ericsson Nikola Tesla d.d

What Is Ericsson Nikola Tesla d.d's Debt?

The image below, which you can click on for greater detail, shows that Ericsson Nikola Tesla d.d had debt of Kn46.9m at the end of September 2020, a reduction from Kn66.9m over a year. But it also has Kn335.3m in cash to offset that, meaning it has Kn288.3m net cash.

How Strong Is Ericsson Nikola Tesla d.d's Balance Sheet?

We can see from the most recent balance sheet that Ericsson Nikola Tesla d.d had liabilities of Kn636.3m falling due within a year, and liabilities of Kn104.2m due beyond that. Offsetting these obligations, it had cash of Kn335.3m as well as receivables valued at Kn399.3m due within 12 months. So these liquid assets roughly match the total liabilities.

Having regard to Ericsson Nikola Tesla d.d's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the Kn1.98b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Ericsson Nikola Tesla d.d also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact Ericsson Nikola Tesla d.d's saving grace is its low debt levels, because its EBIT has tanked 30% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Ericsson Nikola Tesla d.d can strengthen its balance sheet over time. 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. Ericsson Nikola Tesla d.d 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. During the last three years, Ericsson Nikola Tesla d.d generated free cash flow amounting to a very robust 90% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Ericsson Nikola Tesla d.d has Kn288.3m in net cash. The cherry on top was that in converted 90% of that EBIT to free cash flow, bringing in Kn144m. So we don't have any problem with Ericsson Nikola Tesla d.d's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Ericsson Nikola Tesla d.d that you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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