Balco Group (STO:BALCO) Seems To Use Debt Quite Sensibly

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.' 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. As with many other companies Balco Group AB (STO:BALCO) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Balco Group

How Much Debt Does Balco Group Carry?

You can click the graphic below for the historical numbers, but it shows that Balco Group had kr213.4m of debt in December 2020, down from kr244.4m, one year before. However, it does have kr222.0m in cash offsetting this, leading to net cash of kr8.63m.

How Strong Is Balco Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Balco Group had liabilities of kr376.2m due within 12 months and liabilities of kr248.5m due beyond that. On the other hand, it had cash of kr222.0m and kr344.8m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr57.9m.

Given Balco Group has a market capitalization of kr2.01b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Balco Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the bad news is that Balco Group has seen its EBIT plunge 18% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 Balco Group 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Balco Group 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. During the last three years, Balco Group produced sturdy free cash flow equating to 51% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Balco Group has kr8.63m in net cash. So we are not troubled with Balco Group's debt use. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Balco Group insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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. 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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