These 4 Measures Indicate That Sláturfélags Suðurlands svf (ICE:SFS B) Is Using Debt Extensively

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. As with many other companies Sláturfélags Suðurlands svf. (ICE:SFS B) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Sláturfélags Suðurlands svf

How Much Debt Does Sláturfélags Suðurlands svf Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 Sláturfélags Suðurlands svf had Kr2.87b of debt, an increase on Kr2.73b, over one year. On the flip side, it has Kr937.5m in cash leading to net debt of about Kr1.93b.

A Look At Sláturfélags Suðurlands svf's Liabilities

According to the last reported balance sheet, Sláturfélags Suðurlands svf had liabilities of Kr1.80b due within 12 months, and liabilities of Kr4.14b due beyond 12 months. On the other hand, it had cash of Kr937.5m and Kr2.65b worth of receivables due within a year. So it has liabilities totalling Kr2.34b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the Kr1.42b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Sláturfélags Suðurlands svf would likely require a major re-capitalisation if it had to pay its creditors today.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While Sláturfélags Suðurlands svf's low debt to EBITDA ratio of 1.2 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 3.7 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. If Sláturfélags Suðurlands svf can keep growing EBIT at last year's rate of 10% over the last year, then it will find its debt load easier to manage. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Sláturfélags Suðurlands svf will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Sláturfélags Suðurlands svf recorded free cash flow of 37% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

We'd go so far as to say Sláturfélags Suðurlands svf's level of total liabilities was disappointing. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. Looking at the bigger picture, it seems clear to us that Sláturfélags Suðurlands svf's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 4 warning signs for Sláturfélags Suðurlands svf you should be aware of, and 1 of them is potentially serious.

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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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.