Is Orkla (OB:ORK) A Risky Investment?

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. Importantly, Orkla ASA (OB:ORK) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Orkla

How Much Debt Does Orkla Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Orkla had kr19.4b of debt, an increase on kr16.1b, over one year. However, it also had kr1.05b in cash, and so its net debt is kr18.3b.

How Healthy Is Orkla's Balance Sheet?

According to the last reported balance sheet, Orkla had liabilities of kr19.4b due within 12 months, and liabilities of kr21.0b due beyond 12 months. Offsetting these obligations, it had cash of kr1.05b as well as receivables valued at kr10.2b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr29.1b.

This deficit isn't so bad because Orkla is worth kr78.1b, 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.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Orkla's net debt of 2.1 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 8.5 times interest expense) certainly does not do anything to dispel this impression. Unfortunately, Orkla saw its EBIT slide 3.3% in the last twelve months. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Orkla's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Orkla's free cash flow amounted to 50% 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 Orkla was the fact that it seems able to cover its interest expense with its EBIT confidently. However, our other observations weren't so heartening. For example, its EBIT growth rate makes us a little nervous about its debt. When we consider all the factors mentioned above, we do feel a bit cautious about Orkla's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. We'd be motivated to research the stock further if we found out that Orkla insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

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.