Arendals Fossekompani (OB:AFK) Seems To Use Debt Quite Sensibly

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Arendals Fossekompani ASA (OB:AFK) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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.

View our latest analysis for Arendals Fossekompani

What Is Arendals Fossekompani's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Arendals Fossekompani had debt of kr1.31b, up from kr1.02b in one year. However, its balance sheet shows it holds kr2.51b in cash, so it actually has kr1.20b net cash.

A Look At Arendals Fossekompani's Liabilities

Zooming in on the latest balance sheet data, we can see that Arendals Fossekompani had liabilities of kr2.22b due within 12 months and liabilities of kr872.0m due beyond that. On the other hand, it had cash of kr2.51b and kr1.23b worth of receivables due within a year. So it can boast kr652.0m more liquid assets than total liabilities.

This short term liquidity is a sign that Arendals Fossekompani could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Arendals Fossekompani boasts net cash, so it's fair to say it does not have a heavy debt load!

We saw Arendals Fossekompani grow its EBIT by 3.8% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Arendals Fossekompani 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 Arendals Fossekompani 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. Looking at the most recent three years, Arendals Fossekompani recorded free cash flow of 27% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Arendals Fossekompani has net cash of kr1.20b, as well as more liquid assets than liabilities. And it also grew its EBIT by 3.8% over the last year. So we are not troubled with Arendals Fossekompani's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Arendals Fossekompani , and understanding them should be part of your investment process.

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.

If you decide to trade Arendals Fossekompani, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.