Is ASSA ABLOY (STO:ASSA B) A Risky Investment?

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.' 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 ASSA ABLOY AB (publ) (STO:ASSA B) makes use of debt. But the real question is whether this debt is making the company risky.

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for ASSA ABLOY

What Is ASSA ABLOY's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 ASSA ABLOY had kr70.0b of debt, an increase on kr27.8b, over one year. However, because it has a cash reserve of kr6.67b, its net debt is less, at about kr63.3b.

How Strong Is ASSA ABLOY's Balance Sheet?

The latest balance sheet data shows that ASSA ABLOY had liabilities of kr47.9b due within a year, and liabilities of kr69.0b falling due after that. On the other hand, it had cash of kr6.67b and kr29.2b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr81.1b.

ASSA ABLOY has a very large market capitalization of kr275.7b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

ASSA ABLOY's net debt is 2.7 times its EBITDA, which is a significant but still reasonable amount of leverage. But its EBIT was about 15.4 times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. Also relevant is that ASSA ABLOY has grown its EBIT by a very respectable 25% in the last year, thus enhancing its ability to pay down 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 ASSA ABLOY 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, ASSA ABLOY generated free cash flow amounting to a very robust 81% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Happily, ASSA ABLOY's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its net debt to EBITDA does undermine this impression a bit. Looking at the bigger picture, we think ASSA ABLOY's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. 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. We've identified 1 warning sign with ASSA ABLOY , and understanding them should be part of your investment process.

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.