Here's Why AF Gruppen (OB:AFG) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that AF Gruppen ASA (OB:AFG) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

View our latest analysis for AF Gruppen

What Is AF Gruppen's Net Debt?

The image below, which you can click on for greater detail, shows that AF Gruppen had debt of kr163.0m at the end of December 2020, a reduction from kr178.0m over a year. But on the other hand it also has kr708.0m in cash, leading to a kr545.0m net cash position.

How Strong Is AF Gruppen's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that AF Gruppen had liabilities of kr7.94b due within 12 months and liabilities of kr1.43b due beyond that. Offsetting this, it had kr708.0m in cash and kr4.03b in receivables that were due within 12 months. So it has liabilities totalling kr4.63b more than its cash and near-term receivables, combined.

This deficit isn't so bad because AF Gruppen is worth kr18.7b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, AF Gruppen boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, AF Gruppen grew its EBIT by 2.4% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine AF Gruppen's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While AF Gruppen 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, AF Gruppen generated free cash flow amounting to a very robust 89% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While AF Gruppen does have more liabilities than liquid assets, it also has net cash of kr545.0m. And it impressed us with free cash flow of kr1.2b, being 89% of its EBIT. So is AF Gruppen's debt a risk? It doesn't seem so to us. 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. To that end, you should learn about the 2 warning signs we've spotted with AF Gruppen (including 1 which doesn't sit too well with us) .

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. 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.
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