These 4 Measures Indicate That Eimskipafélag Íslands hf (ICE:EIM) Is Using Debt Safely

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Eimskipafélag Íslands hf. (ICE:EIM) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Eimskipafélag Íslands hf

What Is Eimskipafélag Íslands hf's Debt?

The image below, which you can click on for greater detail, shows that Eimskipafélag Íslands hf had debt of €138.2m at the end of September 2022, a reduction from €150.6m over a year. However, it also had €46.6m in cash, and so its net debt is €91.6m.

A Look At Eimskipafélag Íslands hf's Liabilities

We can see from the most recent balance sheet that Eimskipafélag Íslands hf had liabilities of €171.9m falling due within a year, and liabilities of €209.0m due beyond that. On the other hand, it had cash of €46.6m and €194.5m worth of receivables due within a year. So it has liabilities totalling €139.8m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Eimskipafélag Íslands hf has a market capitalization of €640.2m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). 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).

Eimskipafélag Íslands hf has a low net debt to EBITDA ratio of only 0.69. And its EBIT easily covers its interest expense, being 15.2 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Eimskipafélag Íslands hf grew its EBIT by 97% over the last twelve months, and that growth will make it easier to handle 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 Eimskipafélag Íslands 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, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Eimskipafélag Íslands hf generated free cash flow amounting to a very robust 98% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Happily, Eimskipafélag Íslands hf's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Considering this range of factors, it seems to us that Eimskipafélag Íslands hf is quite prudent with its debt, and the risks seem well managed. So we're not worried about the use of a little leverage on the balance sheet. 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 instance, we've identified 1 warning sign for Eimskipafélag Íslands hf that you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.