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The external fund manager backed by Berkshire Hathaway’s Charlie Munger, Li Lu, makes no bones about it when he says ‘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. As with many other companies. XANO Industri AB (publ) (STO:XANO B) makes use of debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 XANO Industri’s Debt?
The chart below, which you can click on for greater detail, shows that XANO Industri had kr665.0m in debt in June 2019; about the same as the year before. However, it also had kr67.0m in cash, and so its net debt is kr598.0m.
How Strong Is XANO Industri’s Balance Sheet?
According to the last reported balance sheet, XANO Industri had liabilities of kr741.0m due within 12 months, and liabilities of kr648.0m due beyond 12 months. Offsetting this, it had kr67.0m in cash and kr526.0m in receivables that were due within 12 months. So it has liabilities totalling kr796.0m more than its cash and near-term receivables, combined.
This deficit isn’t so bad because XANO Industri is worth kr3.28b, 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. Since XANO Industri does have net debt, we think it is worthwhile for shareholders to keep an eye on the balance sheet, over time.
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.
XANO Industri’s net debt to EBITDA ratio of about 1.85 suggests only moderate use of debt. And its commanding EBIT of 12.8 times its interest expense, implies the debt load is as light as a peacock feather. One way XANO Industri could vanquish its debt would be if it stops borrowing more but conitinues to grow EBIT at around 11%, as it did over the last year. There’s no doubt that we learn most about debt from the balance sheet. But you can’t view debt in total isolation; since XANO Industri will need earnings to service that debt. So if you’re keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
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. Looking at the most recent three years, XANO Industri recorded free cash flow of 48% of its EBIT, which is weaker than we’d expect. That weak cash conversion makes it more difficult to handle indebtedness.
XANO Industri’s interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14’s goalkeeper. And we also thought its EBIT growth rate was a positive. Looking at all the aforementioned factors together, it strikes us that XANO Industri can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it’s worth keeping an eye on this one. Over time, share prices tend to follow earnings per share, so if you’re interested in XANO Industri, you may well want to click here to check an interactive graph of its earnings per share history.
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.