Hexatronic Group (STO:HTRO) Seems To Use Debt Quite Sensibly

June 25, 2022
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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Hexatronic Group AB (publ) (STO:HTRO) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Hexatronic Group

What Is Hexatronic Group's Debt?

As you can see below, at the end of March 2022, Hexatronic Group had kr1.22b of debt, up from kr556.2m a year ago. Click the image for more detail. However, because it has a cash reserve of kr257.7m, its net debt is less, at about kr964.5m.

OM:HTRO Debt to Equity History June 25th 2022

How Strong Is Hexatronic Group's Balance Sheet?

The latest balance sheet data shows that Hexatronic Group had liabilities of kr1.27b due within a year, and liabilities of kr1.76b falling due after that. Offsetting these obligations, it had cash of kr257.7m as well as receivables valued at kr880.0m due within 12 months. So it has liabilities totalling kr1.89b more than its cash and near-term receivables, combined.

Given Hexatronic Group has a market capitalization of kr14.9b, 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.

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.

We'd say that Hexatronic Group's moderate net debt to EBITDA ratio ( being 1.7), indicates prudence when it comes to debt. And its commanding EBIT of 21.4 times its interest expense, implies the debt load is as light as a peacock feather. Pleasingly, Hexatronic Group is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 116% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Hexatronic 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Hexatronic Group reported free cash flow worth 8.1% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

The good news is that Hexatronic Group's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. Looking at all the aforementioned factors together, it strikes us that Hexatronic Group can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 4 warning signs for Hexatronic Group (2 make us uncomfortable!) that you should be aware of before investing here.

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.

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Hexatronic Group

Hexatronic Group AB (publ), together with its subsidiaries, designs, develops, manufactures, markets, and sells fiber communication solutions in Sweden and internationally.

Solid track record with reasonable growth potential.