These 4 Measures Indicate That Nordic Flanges Group (STO:NFGAB) Is Using Debt Extensively

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. We note that Nordic Flanges Group AB (publ) (STO:NFGAB) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

Our analysis indicates that NFGAB is potentially overvalued!

What Is Nordic Flanges Group's Debt?

The image below, which you can click on for greater detail, shows that Nordic Flanges Group had debt of kr23.5m at the end of June 2022, a reduction from kr27.4m over a year. However, because it has a cash reserve of kr9.28m, its net debt is less, at about kr14.2m.

How Strong Is Nordic Flanges Group's Balance Sheet?

According to the last reported balance sheet, Nordic Flanges Group had liabilities of kr68.9m due within 12 months, and liabilities of kr34.5m due beyond 12 months. On the other hand, it had cash of kr9.28m and kr26.4m worth of receivables due within a year. So its liabilities total kr67.7m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of kr58.7m, we think shareholders really should watch Nordic Flanges Group's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Nordic Flanges Group has a very low debt to EBITDA ratio of 0.87 so it is strange to see weak interest coverage, with last year's EBIT being only 1.4 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. Notably, Nordic Flanges Group made a loss at the EBIT level, last year, but improved that to positive EBIT of kr6.6m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Nordic Flanges Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, Nordic Flanges Group burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Nordic Flanges Group's interest cover and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. We're quite clear that we consider Nordic Flanges Group to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Nordic Flanges Group you should be aware of.

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.