These 4 Measures Indicate That Eik fasteignafélag hf (ICE:EIK) 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.' 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. We can see that Eik fasteignafélag hf. (ICE:EIK) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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.

See our latest analysis for Eik fasteignafélag hf

What Is Eik fasteignafélag hf's Net Debt?

The chart below, which you can click on for greater detail, shows that Eik fasteignafélag hf had Kr62.0b in debt in December 2020; about the same as the year before. However, it also had Kr1.92b in cash, and so its net debt is Kr60.1b.

A Look At Eik fasteignafélag hf's Liabilities

Zooming in on the latest balance sheet data, we can see that Eik fasteignafélag hf had liabilities of Kr2.62b due within 12 months and liabilities of Kr70.2b due beyond that. On the other hand, it had cash of Kr1.92b and Kr842.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by Kr70.1b.

The deficiency here weighs heavily on the Kr34.2b 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, Eik fasteignafélag hf would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

Eik fasteignafélag hf shareholders face the double whammy of a high net debt to EBITDA ratio (11.1), and fairly weak interest coverage, since EBIT is just 2.2 times the interest expense. The debt burden here is substantial. More concerning, Eik fasteignafélag hf saw its EBIT drop by 2.9% in the last twelve months. If that earnings trend continues the company will face an uphill battle to pay off its debt. 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 Eik fasteignafélag hf 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Eik fasteignafélag hf's free cash flow amounted to 47% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

On the face of it, Eik fasteignafélag hf's net debt to EBITDA left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to convert EBIT to free cash flow isn't such a worry. We're quite clear that we consider Eik fasteignafélag hf to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. Be aware that Eik fasteignafélag hf is showing 5 warning signs in our investment analysis , and 2 of those can't be ignored...

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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