Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Belships ASA (OB:BELCO) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
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How Much Debt Does Belships Carry?
You can click the graphic below for the historical numbers, but it shows that Belships had US$24.6m of debt in March 2022, down from US$134.9m, one year before. However, it does have US$161.2m in cash offsetting this, leading to net cash of US$136.5m.
A Look At Belships' Liabilities
According to the last reported balance sheet, Belships had liabilities of US$141.0m due within 12 months, and liabilities of US$438.9m due beyond 12 months. On the other hand, it had cash of US$161.2m and US$71.3m worth of receivables due within a year. So its liabilities total US$347.4m more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of US$574.6m, so it does suggest shareholders should keep an eye on Belships' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Belships boasts net cash, so it's fair to say it does not have a heavy debt load!
It was also good to see that despite losing money on the EBIT line last year, Belships turned things around in the last 12 months, delivering and EBIT of US$175m. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Belships'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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Belships may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last year, Belships's free cash flow amounted to 44% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Summing up
Although Belships's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$136.5m. So we are not troubled with Belships's debt use. 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 Belships has 4 warning signs (and 2 which are a bit concerning) we think you should know about.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.
About OB:BELCO
Undervalued with excellent balance sheet and pays a dividend.