AF Gruppen (OB:AFG) Seems To Use Debt Quite Sensibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, AF Gruppen ASA (OB:AFG) does carry debt. But the real question is whether this debt is making the company risky.

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

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How Much Debt Does AF Gruppen Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 AF Gruppen had kr181.0m of debt, an increase on kr171.0m, over one year. However, its balance sheet shows it holds kr1.04b in cash, so it actually has kr855.0m net cash.

How Strong Is AF Gruppen's Balance Sheet?

According to the last reported balance sheet, AF Gruppen had liabilities of kr9.85b due within 12 months, and liabilities of kr1.56b due beyond 12 months. On the other hand, it had cash of kr1.04b and kr5.64b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr4.74b.

AF Gruppen has a market capitalization of kr14.8b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, AF Gruppen also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, AF Gruppen saw its EBIT drop by 4.3% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if AF Gruppen can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. AF Gruppen may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, AF Gruppen actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

Although AF Gruppen's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of kr855.0m. And it impressed us with free cash flow of kr1.6b, being 110% of its EBIT. So we are not troubled with AF Gruppen's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for AF Gruppen that you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.