Is Arendals Fossekompani (OB:AFK) A Risky Investment?

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Arendals Fossekompani ASA (OB:AFK) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Arendals Fossekompani

How Much Debt Does Arendals Fossekompani Carry?

As you can see below, Arendals Fossekompani had kr1.17b of debt at September 2022, down from kr1.22b a year prior. But it also has kr2.32b in cash to offset that, meaning it has kr1.15b net cash.

How Strong Is Arendals Fossekompani's Balance Sheet?

According to the last reported balance sheet, Arendals Fossekompani had liabilities of kr2.36b due within 12 months, and liabilities of kr1.14b due beyond 12 months. Offsetting these obligations, it had cash of kr2.32b as well as receivables valued at kr1.32b due within 12 months. So it can boast kr137.0m more liquid assets than total liabilities.

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 kr14.1b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Arendals Fossekompani boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Arendals Fossekompani grew its EBIT by 54% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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. Over the most recent three years, Arendals Fossekompani recorded free cash flow worth 65% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Arendals Fossekompani has net cash of kr1.15b, as well as more liquid assets than liabilities. And we liked the look of last year's 54% year-on-year EBIT growth. So is Arendals Fossekompani'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. Case in point: We've spotted 1 warning sign for Arendals Fossekompani you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.