Is AB SKF (STO:SKF B) A Risky Investment?

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. As with many other companies AB SKF (publ) (STO:SKF B) makes use of debt. But the real question is whether this debt is making the company risky.

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When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

What Is AB SKF's Debt?

As you can see below, AB SKF had kr17.2b of debt at December 2024, down from kr19.1b a year prior. However, it does have kr11.1b in cash offsetting this, leading to net debt of about kr6.15b.

A Look At AB SKF's Liabilities

Zooming in on the latest balance sheet data, we can see that AB SKF had liabilities of kr30.1b due within 12 months and liabilities of kr27.3b due beyond that. On the other hand, it had cash of kr11.1b and kr21.7b worth of receivables due within a year. So its liabilities total kr24.6b more than the combination of its cash and short-term receivables.

AB SKF has a market capitalization of kr99.6b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

Check out our latest analysis for AB SKF

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

AB SKF has a low net debt to EBITDA ratio of only 0.45. And its EBIT easily covers its interest expense, being 28.0 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the other side of the story is that AB SKF saw its EBIT decline by 3.8% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine AB SKF'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, AB SKF recorded free cash flow of 46% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Both AB SKF's ability to to cover its interest expense with its EBIT and its net debt to EBITDA gave us comfort that it can handle its debt. Having said that, its EBIT growth rate somewhat sensitizes us to potential future risks to the balance sheet. 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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that AB SKF is showing 1 warning sign in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.