We Think Arendals Fossekompani (OB:AFK) Can Stay On Top Of Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Arendals Fossekompani ASA (OB:AFK) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Arendals Fossekompani

What Is Arendals Fossekompani's Debt?

As you can see below, at the end of March 2021, Arendals Fossekompani had kr1.81b of debt, up from kr1.31b a year ago. Click the image for more detail. However, it does have kr4.05b in cash offsetting this, leading to net cash of kr2.24b.

A Look At Arendals Fossekompani's Liabilities

We can see from the most recent balance sheet that Arendals Fossekompani had liabilities of kr2.48b falling due within a year, and liabilities of kr1.40b due beyond that. On the other hand, it had cash of kr4.05b and kr1.91b worth of receivables due within a year. So it actually has kr2.07b 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!

Fortunately, Arendals Fossekompani grew its EBIT by 3.2% in the last year, making that debt load look even more manageable. 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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. During the last three years, Arendals Fossekompani produced sturdy free cash flow equating to 55% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Arendals Fossekompani has net cash of kr2.24b, as well as more liquid assets than liabilities. So is Arendals Fossekompani's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Arendals Fossekompani (of which 1 shouldn't be ignored!) you should know about.

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.

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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.
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