These 4 Measures Indicate That Skanska (STO:SKA B) Is Using Debt Reasonably Well

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.' 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. Importantly, Skanska AB (publ) (STO:SKA B) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Skanska

How Much Debt Does Skanska Carry?

As you can see below, Skanska had kr7.91b of debt at June 2021, down from kr8.87b a year prior. But on the other hand it also has kr25.4b in cash, leading to a kr17.5b net cash position.

A Look At Skanska's Liabilities

The latest balance sheet data shows that Skanska had liabilities of kr70.5b due within a year, and liabilities of kr16.5b falling due after that. Offsetting these obligations, it had cash of kr25.4b as well as receivables valued at kr30.2b due within 12 months. So it has liabilities totalling kr31.4b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Skanska has a huge market capitalization of kr99.7b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Skanska boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Skanska saw its EBIT decline by 9.8% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Skanska's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Skanska has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Skanska recorded free cash flow worth a fulsome 90% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While Skanska does have more liabilities than liquid assets, it also has net cash of kr17.5b. The cherry on top was that in converted 90% of that EBIT to free cash flow, bringing in kr7.1b. So we don't have any problem with Skanska's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Skanska is showing 2 warning signs in our investment analysis , and 1 of those is concerning...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.
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