Axfood (STO:AXFO) Seems To Use Debt Quite Sensibly

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. We note that Axfood AB (publ) (STO:AXFO) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Axfood

What Is Axfood's Debt?

The image below, which you can click on for greater detail, shows that Axfood had debt of kr200.0m at the end of December 2022, a reduction from kr1.60b over a year. However, it does have kr559.0m in cash offsetting this, leading to net cash of kr359.0m.

A Look At Axfood's Liabilities

The latest balance sheet data shows that Axfood had liabilities of kr12.7b due within a year, and liabilities of kr8.97b falling due after that. Offsetting these obligations, it had cash of kr559.0m as well as receivables valued at kr3.58b due within 12 months. So it has liabilities totalling kr17.6b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Axfood has a market capitalization of kr56.2b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Axfood boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Axfood grew its EBIT at 12% 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 ultimately the future profitability of the business will decide if Axfood can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Axfood 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. Happily for any shareholders, Axfood actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

Although Axfood's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of kr359.0m. The cherry on top was that in converted 123% of that EBIT to free cash flow, bringing in kr3.3b. So we don't think Axfood's use of debt is risky. 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. Be aware that Axfood is showing 1 warning sign in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.