Green Landscaping Group (STO:GREEN) Seems To Use Debt Quite Sensibly

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. As with many other companies Green Landscaping Group AB (publ) (STO:GREEN) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Green Landscaping Group

What Is Green Landscaping Group's Debt?

As you can see below, at the end of December 2022, Green Landscaping Group had kr1.83b of debt, up from kr1.12b a year ago. Click the image for more detail. On the flip side, it has kr476.0m in cash leading to net debt of about kr1.36b.

How Healthy Is Green Landscaping Group's Balance Sheet?

According to the last reported balance sheet, Green Landscaping Group had liabilities of kr1.28b due within 12 months, and liabilities of kr2.40b due beyond 12 months. On the other hand, it had cash of kr476.0m and kr1.21b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr2.00b.

While this might seem like a lot, it is not so bad since Green Landscaping Group has a market capitalization of kr4.13b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). 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).

Green Landscaping Group's net debt is sitting at a very reasonable 2.4 times its EBITDA, while its EBIT covered its interest expense just 5.4 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. It is well worth noting that Green Landscaping Group's EBIT shot up like bamboo after rain, gaining 91% 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 Green Landscaping Group'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Green Landscaping Group actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Happily, Green Landscaping Group's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But truth be told we feel its level of total liabilities does undermine this impression a bit. Taking all this data into account, it seems to us that Green Landscaping Group takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with Green Landscaping Group .

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.

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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.