Does AB SKF (STO:SKF B) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, AB SKF (publ) (STO:SKF B) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for AB SKF

What Is AB SKF's Debt?

As you can see below, AB SKF had kr16.0b of debt at March 2021, down from kr17.2b a year prior. However, it does have kr15.0b in cash offsetting this, leading to net debt of about kr963.0m.

How Healthy Is AB SKF's Balance Sheet?

We can see from the most recent balance sheet that AB SKF had liabilities of kr20.9b falling due within a year, and liabilities of kr34.3b due beyond that. Offsetting this, it had kr15.0b in cash and kr14.8b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr25.5b.

This deficit isn't so bad because AB SKF is worth a massive kr100.5b, 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. But either way, AB SKF has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

AB SKF has a low net debt to EBITDA ratio of only 0.10. And its EBIT covers its interest expense a whopping 553 times over. So we're pretty relaxed about its super-conservative use of debt. But the bad news is that AB SKF has seen its EBIT plunge 19% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 AB SKF 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, AB SKF recorded free cash flow worth 61% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

AB SKF's interest cover was a real positive on this analysis, as was its net debt to EBITDA. In contrast, our confidence was undermined by its apparent struggle to grow its EBIT. Considering this range of data points, we think AB SKF is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for AB SKF you should know about.

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. 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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