Is Kongsberg Automotive (OB:KOA) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Kongsberg Automotive ASA (OB:KOA) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

See our latest analysis for Kongsberg Automotive

What Is Kongsberg Automotive's Debt?

As you can see below, Kongsberg Automotive had €197.9m of debt at December 2022, down from €292.7m a year prior. However, it does have €212.9m in cash offsetting this, leading to net cash of €15.0m.

A Look At Kongsberg Automotive's Liabilities

We can see from the most recent balance sheet that Kongsberg Automotive had liabilities of €214.4m falling due within a year, and liabilities of €303.0m due beyond that. Offsetting this, it had €212.9m in cash and €188.9m in receivables that were due within 12 months. So its liabilities total €115.6m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of €191.8m, so it does suggest shareholders should keep an eye on Kongsberg Automotive's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, Kongsberg Automotive also has more cash than debt, so we're pretty confident it can manage its debt safely.

Shareholders should be aware that Kongsberg Automotive's EBIT was down 57% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Kongsberg Automotive 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Kongsberg Automotive has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Kongsberg Automotive generated free cash flow amounting to a very robust 85% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

Although Kongsberg Automotive's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €15.0m. The cherry on top was that in converted 85% of that EBIT to free cash flow, bringing in €74m. So although we see some areas for improvement, we're not too worried about Kongsberg Automotive's balance sheet. 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. We've identified 2 warning signs with Kongsberg Automotive , and understanding them should be part of your investment process.

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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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.