Is Klappir Grænar Lausnir hf (ICE:KLAPP B) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Klappir Grænar Lausnir hf. (ICE:KLAPP B) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Klappir Grænar Lausnir hf

What Is Klappir Grænar Lausnir hf's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Klappir Grænar Lausnir hf had Kr313.1m of debt, an increase on Kr213.5m, over one year. However, it also had Kr158.6m in cash, and so its net debt is Kr154.5m.

A Look At Klappir Grænar Lausnir hf's Liabilities

According to the last reported balance sheet, Klappir Grænar Lausnir hf had liabilities of Kr124.8m due within 12 months, and liabilities of Kr348.5m due beyond 12 months. Offsetting this, it had Kr158.6m in cash and Kr336.8m in receivables that were due within 12 months. So it can boast Kr22.1m more liquid assets than total liabilities.

This state of affairs indicates that Klappir Grænar Lausnir hf's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the Kr2.64b company is struggling for cash, we still think it's worth monitoring its balance sheet.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Even though Klappir Grænar Lausnir hf's debt is only 2.1, its interest cover is really very low at 1.2. This does suggest the company is paying fairly high interest rates. Either way there's no doubt the stock is using meaningful leverage. We also note that Klappir Grænar Lausnir hf improved its EBIT from a last year's loss to a positive Kr55m. 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 Klappir Grænar Lausnir hf will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Klappir Grænar Lausnir hf saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Both Klappir Grænar Lausnir hf's conversion of EBIT to free cash flow and its interest cover were discouraging. At least its level of total liabilities gives us reason to be optimistic. Taking the abovementioned factors together we do think Klappir Grænar Lausnir hf's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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 3 warning signs for Klappir Grænar Lausnir hf (1 is a bit unpleasant) 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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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.