These 4 Measures Indicate That Skanska (STO:SKA 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.' 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 Skanska AB (publ) (STO:SKA B) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Skanska

What Is Skanska's Net Debt?

As you can see below, Skanska had kr8.66b of debt, at September 2021, which is about the same as the year before. You can click the chart for greater detail. But it also has kr26.8b in cash to offset that, meaning it has kr18.1b net cash.

How Strong Is Skanska's Balance Sheet?

The latest balance sheet data shows that Skanska had liabilities of kr73.5b due within a year, and liabilities of kr16.8b falling due after that. Offsetting these obligations, it had cash of kr26.8b as well as receivables valued at kr31.3b due within 12 months. So it has liabilities totalling kr32.2b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Skanska is worth a massive kr92.2b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Skanska also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the bad news is that Skanska has seen its EBIT plunge 15% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 Skanska 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. Skanska 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. During the last three years, Skanska generated free cash flow amounting to a very robust 92% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While Skanska does have more liabilities than liquid assets, it also has net cash of kr18.1b. And it impressed us with free cash flow of kr6.3b, being 92% of its EBIT. So we are not troubled with Skanska's debt use. 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. We've identified 2 warning signs with Skanska (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.