These 4 Measures Indicate That OEM International (STO:OEM B) Is Using Debt Reasonably Well

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies OEM International AB (publ) (STO:OEM B) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for OEM International

How Much Debt Does OEM International Carry?

As you can see below, OEM International had kr57.0m of debt at September 2024, down from kr138.0m a year prior. However, its balance sheet shows it holds kr407.0m in cash, so it actually has kr350.0m net cash.

A Look At OEM International's Liabilities

The latest balance sheet data shows that OEM International had liabilities of kr711.0m due within a year, and liabilities of kr216.0m falling due after that. On the other hand, it had cash of kr407.0m and kr883.0m worth of receivables due within a year. So it actually has kr363.0m more liquid assets than total liabilities.

This short term liquidity is a sign that OEM International could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that OEM International has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, OEM International saw its EBIT drop by 7.2% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since OEM International will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. OEM International 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. Over the most recent three years, OEM International recorded free cash flow worth 70% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that OEM International has net cash of kr350.0m, as well as more liquid assets than liabilities. The cherry on top was that in converted 70% of that EBIT to free cash flow, bringing in kr767m. So is OEM International's debt a risk? It doesn't seem so to us. We'd be motivated to research the stock further if we found out that OEM International insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

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.