Is Crayon Group Holding (OB:CRAYN) A Risky Investment?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Crayon Group Holding ASA (OB:CRAYN) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Crayon Group Holding

What Is Crayon Group Holding's Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Crayon Group Holding had debt of kr2.21b, up from kr396.6m in one year. However, it also had kr1.21b in cash, and so its net debt is kr996.2m.

A Look At Crayon Group Holding's Liabilities

Zooming in on the latest balance sheet data, we can see that Crayon Group Holding had liabilities of kr11.2b due within 12 months and liabilities of kr2.05b due beyond that. Offsetting this, it had kr1.21b in cash and kr10.2b in receivables that were due within 12 months. So its liabilities total kr1.84b more than the combination of its cash and short-term receivables.

Crayon Group Holding has a market capitalization of kr8.80b, so it could very likely raise cash to ameliorate 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Crayon Group Holding's net debt is sitting at a very reasonable 1.8 times its EBITDA, while its EBIT covered its interest expense just 4.1 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. It is well worth noting that Crayon Group Holding's EBIT shot up like bamboo after rain, gaining 46% in the last twelve months. That'll make it easier to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Crayon Group Holding can strengthen its balance sheet over time. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Crayon Group Holding produced sturdy free cash flow equating to 56% 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

Crayon Group Holding's EBIT growth rate suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its interest cover. Looking at all the aforementioned factors together, it strikes us that Crayon Group Holding can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. We've identified 3 warning signs with Crayon Group Holding (at least 1 which shouldn't be ignored) , 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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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.