Here's Why Austevoll Seafood (OB:AUSS) Can Manage Its Debt Responsibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Austevoll Seafood ASA (OB:AUSS) makes use of debt. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

View our latest analysis for Austevoll Seafood

What Is Austevoll Seafood's Net Debt?

The chart below, which you can click on for greater detail, shows that Austevoll Seafood had kr7.38b in debt in March 2021; about the same as the year before. However, because it has a cash reserve of kr4.77b, its net debt is less, at about kr2.61b.

How Healthy Is Austevoll Seafood's Balance Sheet?

According to the last reported balance sheet, Austevoll Seafood had liabilities of kr5.40b due within 12 months, and liabilities of kr11.6b due beyond 12 months. Offsetting this, it had kr4.77b in cash and kr3.05b in receivables that were due within 12 months. So it has liabilities totalling kr9.23b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Austevoll Seafood is worth kr23.6b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With net debt sitting at just 0.89 times EBITDA, Austevoll Seafood is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 7.0 times the interest expense over the last year. On the other hand, Austevoll Seafood saw its EBIT drop by 2.9% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Austevoll Seafood'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, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Austevoll Seafood produced sturdy free cash flow equating to 59% 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.

Our View

Austevoll Seafood's net debt to EBITDA was a real positive on this analysis, as was its conversion of EBIT to free cash flow. On the other hand, its EBIT growth rate makes us a little less comfortable about its debt. Considering this range of data points, we think Austevoll Seafood 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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Austevoll Seafood that you should be aware of before investing here.

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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