Is Absolent Air Care Group (STO:ABSO) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, Absolent Air Care Group AB (publ) (STO:ABSO) 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. 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. 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.

View our latest analysis for Absolent Air Care Group

What Is Absolent Air Care Group's Net Debt?

The image below, which you can click on for greater detail, shows that Absolent Air Care Group had debt of kr546.1m at the end of December 2021, a reduction from kr581.7m over a year. However, because it has a cash reserve of kr233.2m, its net debt is less, at about kr312.9m.

A Look At Absolent Air Care Group's Liabilities

We can see from the most recent balance sheet that Absolent Air Care Group had liabilities of kr247.5m falling due within a year, and liabilities of kr679.7m due beyond that. Offsetting these obligations, it had cash of kr233.2m as well as receivables valued at kr253.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr440.9m.

Since publicly traded Absolent Air Care Group shares are worth a total of kr4.29b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). 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).

Absolent Air Care Group's net debt to EBITDA ratio of about 2.1 suggests only moderate use of debt. And its commanding EBIT of 16.3 times its interest expense, implies the debt load is as light as a peacock feather. Notably, Absolent Air Care Group's EBIT launched higher than Elon Musk, gaining a whopping 406% on last year. There's no doubt that we learn most about debt from the balance sheet. But it is Absolent Air Care Group's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Absolent Air Care Group produced sturdy free cash flow equating to 78% 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

The good news is that Absolent Air Care Group's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Considering this range of factors, it seems to us that Absolent Air Care Group is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Absolent Air Care Group (1 is a bit unpleasant) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.