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 Olav Thon Eiendomsselskap ASA (OB:OLT) makes use of debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for Olav Thon Eiendomsselskap
What Is Olav Thon Eiendomsselskap's Net Debt?
As you can see below, Olav Thon Eiendomsselskap had kr21.8b of debt at March 2021, down from kr23.7b a year prior. Net debt is about the same, since the it doesn't have much cash.
A Look At Olav Thon Eiendomsselskap's Liabilities
The latest balance sheet data shows that Olav Thon Eiendomsselskap had liabilities of kr6.93b due within a year, and liabilities of kr24.0b falling due after that. Offsetting these obligations, it had cash of kr367.0m as well as receivables valued at kr793.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr29.8b.
This deficit casts a shadow over the kr18.5b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Olav Thon Eiendomsselskap would probably need a major re-capitalization if its creditors were to demand repayment.
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.
As it happens Olav Thon Eiendomsselskap has a fairly concerning net debt to EBITDA ratio of 7.8 but very strong interest coverage of 1k. So either it has access to very cheap long term debt or that interest expense is going to grow! One way Olav Thon Eiendomsselskap could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 12%, as it did over the last year. 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 Olav Thon Eiendomsselskap'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. During the last three years, Olav Thon Eiendomsselskap produced sturdy free cash flow equating to 58% 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
To be frank both Olav Thon Eiendomsselskap's net debt to EBITDA and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Olav Thon Eiendomsselskap stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example Olav Thon Eiendomsselskap has 3 warning signs (and 2 which can't be ignored) we think you should know about.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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About OB:OLT
Olav Thon Eiendomsselskap
Engages in the property rental business in Norway and Sweden.
Reasonable growth potential and fair value.