Here's Why Arendals Fossekompani (OB:AFK) 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.' 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?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See 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 June 2021 Arendals Fossekompani had debt of kr1.58b, up from kr1.40b in one year. But it also has kr2.76b in cash to offset that, meaning it has kr1.19b net cash.

A Look At Arendals Fossekompani's Liabilities

The latest balance sheet data shows that Arendals Fossekompani had liabilities of kr2.60b due within a year, and liabilities of kr1.05b falling due after that. Offsetting these obligations, it had cash of kr2.76b as well as receivables valued at kr902.0m due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

Having regard to Arendals Fossekompani's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the kr17.8b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Arendals Fossekompani has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Arendals Fossekompani has boosted its EBIT by 61%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is Arendals Fossekompani's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Arendals Fossekompani 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. In the last three years, Arendals Fossekompani's free cash flow amounted to 27% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Arendals Fossekompani has kr1.19b in net cash and a decent-looking balance sheet. And we liked the look of last year's 61% year-on-year EBIT growth. So we don't think Arendals Fossekompani's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 3 warning signs we've spotted with Arendals Fossekompani (including 2 which are a bit concerning) .

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. 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.
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