Is Svedbergs i Dalstorp (STO:SVED B) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, Svedbergs i Dalstorp AB (publ) (STO:SVED B) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Svedbergs i Dalstorp

What Is Svedbergs i Dalstorp's Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Svedbergs i Dalstorp had debt of kr236.7m, up from kr225.1m in one year. However, because it has a cash reserve of kr58.4m, its net debt is less, at about kr178.3m.

How Healthy Is Svedbergs i Dalstorp's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Svedbergs i Dalstorp had liabilities of kr250.7m due within 12 months and liabilities of kr196.1m due beyond that. Offsetting these obligations, it had cash of kr58.4m as well as receivables valued at kr145.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr243.1m.

Svedbergs i Dalstorp has a market capitalization of kr946.0m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). 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).

Svedbergs i Dalstorp's net debt to EBITDA ratio of about 1.7 suggests only moderate use of debt. And its strong interest cover of 18.7 times, makes us even more comfortable. It is well worth noting that Svedbergs i Dalstorp's EBIT shot up like bamboo after rain, gaining 35% in the last twelve months. That'll make it easier to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Svedbergs i Dalstorp's ability to maintain a healthy balance sheet going forward. 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. During the last three years, Svedbergs i Dalstorp produced sturdy free cash flow equating to 74% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Svedbergs i Dalstorp's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Zooming out, Svedbergs i Dalstorp seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Svedbergs i Dalstorp that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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