Is Bong (STO:BONG) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Bong AB (publ) (STO:BONG) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Bong

What Is Bong's Debt?

As you can see below, Bong had kr220.7m of debt at March 2023, down from kr243.8m a year prior. However, it does have kr148.5m in cash offsetting this, leading to net debt of about kr72.2m.

A Look At Bong's Liabilities

We can see from the most recent balance sheet that Bong had liabilities of kr584.5m falling due within a year, and liabilities of kr529.2m due beyond that. Offsetting this, it had kr148.5m in cash and kr223.7m in receivables that were due within 12 months. So it has liabilities totalling kr741.5m more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the kr247.1m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Bong would likely require a major re-capitalisation if it had to pay its creditors today.

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).

While Bong's low debt to EBITDA ratio of 0.54 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 3.5 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Pleasingly, Bong is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 448% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Bong'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 we always check how much of that EBIT is translated into free cash flow. Over the last three years, Bong recorded free cash flow worth a fulsome 97% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Bong's level of total liabilities was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to convert EBIT to free cash flow is pretty flash. When we consider all the factors mentioned above, we do feel a bit cautious about Bong's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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 Bong is showing 2 warning signs in our investment analysis , and 1 of those is significant...

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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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.