Is XXL (OB:XXL) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 XXL ASA (OB:XXL) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for XXL

How Much Debt Does XXL Carry?

The image below, which you can click on for greater detail, shows that XXL had debt of kr486.0m at the end of March 2021, a reduction from kr1.68b over a year. However, because it has a cash reserve of kr481.0m, its net debt is less, at about kr5.00m.

How Strong Is XXL's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that XXL had liabilities of kr1.99b due within 12 months and liabilities of kr2.49b due beyond that. Offsetting these obligations, it had cash of kr481.0m as well as receivables valued at kr197.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr3.81b.

This deficit is considerable relative to its market capitalization of kr4.95b, so it does suggest shareholders should keep an eye on XXL's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. But either way, XXL has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With net debt at just 0.0075 times EBITDA, it seems XXL only uses a little bit of leverage. But EBIT was only 4.5 times the interest expense last year, so the borrowing is clearly weighing on the business somewhat. We also note that XXL improved its EBIT from a last year's loss to a positive kr596m. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if XXL can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, XXL actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

XXL's conversion of EBIT to free cash flow was a real positive on this analysis, as was its net debt to EBITDA. On the other hand, its level of total liabilities makes us a little less comfortable about its debt. Considering this range of data points, we think XXL 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. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that XXL insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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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This article by Simply Wall St is general in nature. 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.
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