These 4 Measures Indicate That Sweco (STO:SWEC B) Is Using Debt Safely

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Sweco AB (publ) (STO:SWEC B) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Sweco

What Is Sweco's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2022 Sweco had debt of kr1.93b, up from kr1.81b in one year. However, because it has a cash reserve of kr850.0m, its net debt is less, at about kr1.08b.

How Healthy Is Sweco's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sweco had liabilities of kr8.05b due within 12 months and liabilities of kr3.93b due beyond that. Offsetting these obligations, it had cash of kr850.0m as well as receivables valued at kr8.22b due within 12 months. So its liabilities total kr2.90b more than the combination of its cash and short-term receivables.

Since publicly traded Sweco shares are worth a total of kr43.6b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Sweco's net debt is only 0.41 times its EBITDA. And its EBIT easily covers its interest expense, being 24.1 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also good is that Sweco grew its EBIT at 10% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Sweco'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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Sweco actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Happily, Sweco's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Overall, we don't think Sweco is taking any bad risks, as its debt load seems modest. So the balance sheet looks pretty healthy, to us. 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. Case in point: We've spotted 1 warning sign for Sweco you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.