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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘Volatility is far from synonymous with risk.’ 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. We note that Beijer Ref AB (publ) (STO:BEIJ B) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company’s debt levels is to consider its cash and debt together.
How Much Debt Does Beijer Ref Carry?
The image below, which you can click on for greater detail, shows that at March 2019 Beijer Ref had debt of kr3.70b, up from kr2.10b in one year. However, it does have kr774.0m in cash offsetting this, leading to net debt of about kr2.92b.
How Healthy Is Beijer Ref’s Balance Sheet?
The latest balance sheet data shows that Beijer Ref had liabilities of kr3.66b due within a year, and liabilities of kr3.70b falling due after that. Offsetting these obligations, it had cash of kr774.0m as well as receivables valued at kr2.86b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr3.72b.
Since publicly traded Beijer Ref shares are worth a total of kr28.8b, 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. Either way, since Beijer Ref does have more debt than cash, it’s worth keeping an eye on its balance sheet.
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).
We’d say that Beijer Ref’s moderate net debt to EBITDA ratio ( being 2.34), indicates prudence when it comes to debt. And its strong interest cover of 23.7 times, makes us even more comfortable. Importantly, Beijer Ref grew its EBIT by 46% over the last twelve months, and that growth will make it easier to handle its debt. 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 Beijer Ref 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Beijer Ref recorded free cash flow of 45% of its EBIT, which is weaker than we’d expect. That’s not great, when it comes to paying down debt.
The good news is that Beijer Ref’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. When we consider the range of factors above, it looks like Beijer Ref is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. Of course, we wouldn’t say no to the extra confidence that we’d gain if we knew that Beijer Ref insiders have been buying shares: if you’re on the same wavelength, you can find out if insiders are buying by clicking this link.
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.