Is AF Gruppen (OB:AFG) Using Too Much Debt?

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.' 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 is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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.

View our latest analysis for AF Gruppen

What Is AF Gruppen's Net Debt?

As you can see below, AF Gruppen had kr171.0m of debt, at September 2021, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has kr593.0m in cash, leading to a kr422.0m net cash position.

How Healthy Is AF Gruppen's Balance Sheet?

According to the last reported balance sheet, AF Gruppen had liabilities of kr8.39b due within 12 months, and liabilities of kr1.37b due beyond 12 months. Offsetting these obligations, it had cash of kr593.0m as well as receivables valued at kr4.56b due within 12 months. So it has liabilities totalling kr4.61b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since AF Gruppen has a market capitalization of kr19.7b, and so it could probably strengthen its balance sheet by raising capital if it needed to. 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.

Another good sign is that AF Gruppen has been able to increase its EBIT by 25% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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 generation warms our hearts like a puppy in a bumblebee suit.

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 kr422.0m. The cherry on top was that in converted 100% of that EBIT to free cash flow, bringing in kr810m. 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.

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.