These 4 Measures Indicate That Lerøy Seafood Group (OB:LSG) Is Using Debt Reasonably Well

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. We note that Lerøy Seafood Group ASA (OB:LSG) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Lerøy Seafood Group

How Much Debt Does Lerøy Seafood Group Carry?

The chart below, which you can click on for greater detail, shows that Lerøy Seafood Group had kr4.98b in debt in March 2021; about the same as the year before. However, because it has a cash reserve of kr3.17b, its net debt is less, at about kr1.82b.

How Strong Is Lerøy Seafood Group's Balance Sheet?

The latest balance sheet data shows that Lerøy Seafood Group had liabilities of kr4.03b due within a year, and liabilities of kr8.68b falling due after that. Offsetting these obligations, it had cash of kr3.17b as well as receivables valued at kr2.51b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr7.03b.

Of course, Lerøy Seafood Group has a market capitalization of kr46.5b, 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.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Lerøy Seafood Group's net debt is only 0.77 times its EBITDA. And its EBIT covers its interest expense a whopping 10.9 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In fact Lerøy Seafood Group's saving grace is its low debt levels, because its EBIT has tanked 22% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Lerøy Seafood Group'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Lerøy Seafood Group recorded free cash flow worth 58% 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.

Our View

Based on what we've seen Lerøy Seafood Group is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. When we consider all the factors mentioned above, we do feel a bit cautious about Lerøy Seafood Group's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Lerøy Seafood Group , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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