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

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 AF Gruppen

What Is AF Gruppen's Debt?

As you can see below, at the end of June 2022, AF Gruppen had kr375.0m of debt, up from kr151.0m a year ago. Click the image for more detail. But on the other hand it also has kr1.09b in cash, leading to a kr711.0m net cash position.

A Look At AF Gruppen's Liabilities

We can see from the most recent balance sheet that AF Gruppen had liabilities of kr9.52b falling due within a year, and liabilities of kr1.44b due beyond that. Offsetting this, it had kr1.09b in cash and kr5.18b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr4.70b.

While this might seem like a lot, it is not so bad since AF Gruppen has a market capitalization of kr16.9b, 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. Despite its noteworthy liabilities, AF Gruppen boasts net cash, so it's fair to say it does not have a heavy debt load!

While AF Gruppen doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if AF Gruppen can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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. Over the last three years, AF Gruppen actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While AF Gruppen does have more liabilities than liquid assets, it also has net cash of kr711.0m. And it impressed us with free cash flow of kr1.7b, being 108% of its EBIT. So is AF Gruppen's debt a risk? It doesn't seem so to us. 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. We've identified 1 warning sign with AF Gruppen , and understanding them should be part of your investment process.

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.