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.' 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. As with many other companies Arendals Fossekompani ASA (OB:AFK) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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

See our latest analysis for Arendals Fossekompani

What Is Arendals Fossekompani's Net Debt?

As you can see below, at the end of March 2023, Arendals Fossekompani had kr1.20b of debt, up from kr909.0m a year ago. Click the image for more detail. However, it does have kr2.29b in cash offsetting this, leading to net cash of kr1.09b.

A Look At Arendals Fossekompani's Liabilities

We can see from the most recent balance sheet that Arendals Fossekompani had liabilities of kr3.32b falling due within a year, and liabilities of kr1.20b due beyond that. Offsetting this, it had kr2.29b in cash and kr1.51b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr718.0m.

Of course, Arendals Fossekompani has a market capitalization of kr9.18b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Arendals Fossekompani boasts net cash, so it's fair to say it does not have a heavy debt load!

Arendals Fossekompani's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Arendals Fossekompani's earnings that will influence how the balance sheet holds up in the future. 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. Over the most recent three years, Arendals Fossekompani recorded free cash flow worth 57% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

We could understand if investors are concerned about Arendals Fossekompani's liabilities, but we can be reassured by the fact it has has net cash of kr1.09b. So we are not troubled with Arendals Fossekompani's debt use. 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 1 warning sign for Arendals Fossekompani you should know about.

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.