Is AB Electrolux (STO:ELUX B) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 AB Electrolux (publ) (STO:ELUX B) makes use of debt. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for AB Electrolux

What Is AB Electrolux's Debt?

You can click the graphic below for the historical numbers, but it shows that AB Electrolux had kr15.2b of debt in June 2021, down from kr19.8b, one year before. But on the other hand it also has kr18.3b in cash, leading to a kr3.08b net cash position.

How Strong Is AB Electrolux's Balance Sheet?

The latest balance sheet data shows that AB Electrolux had liabilities of kr63.7b due within a year, and liabilities of kr20.4b falling due after that. On the other hand, it had cash of kr18.3b and kr21.4b worth of receivables due within a year. So its liabilities total kr44.4b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of kr63.7b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, AB Electrolux also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, AB Electrolux grew its EBIT by 335% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if AB Electrolux can strengthen its balance sheet over time. 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. While AB Electrolux has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, AB Electrolux produced sturdy free cash flow equating to 76% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

Although AB Electrolux's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of kr3.08b. And it impressed us with its EBIT growth of 335% over the last year. So we don't think AB Electrolux's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for AB Electrolux (1 can't be ignored) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.
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