Tomra Systems (OB:TOM) 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. We can see that Tomra Systems ASA (OB:TOM) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Tomra Systems

What Is Tomra Systems's Debt?

As you can see below, at the end of September 2023, Tomra Systems had kr3.37b of debt, up from kr2.09b a year ago. Click the image for more detail. However, it does have kr508.0m in cash offsetting this, leading to net debt of about kr2.86b.

How Strong Is Tomra Systems' Balance Sheet?

The latest balance sheet data shows that Tomra Systems had liabilities of kr1.97b due within a year, and liabilities of kr6.98b falling due after that. Offsetting this, it had kr508.0m in cash and kr4.65b in receivables that were due within 12 months. So its liabilities total kr3.80b more than the combination of its cash and short-term receivables.

Since publicly traded Tomra Systems shares are worth a total of kr30.6b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Tomra Systems has a low net debt to EBITDA ratio of only 1.4. And its EBIT covers its interest expense a whopping 10.0 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Tomra Systems'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. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Tomra Systems's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Tomra Systems's free cash flow amounted to 46% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

When it comes to the balance sheet, the standout positive for Tomra Systems was the fact that it seems able to cover its interest expense with its EBIT confidently. But the other factors we noted above weren't so encouraging. For example, its EBIT growth rate makes us a little nervous about its debt. Considering this range of data points, we think Tomra Systems is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. For example - Tomra Systems has 1 warning sign we think you should be aware of.

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. 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.