Is Scandic Hotels Group (STO:SHOT) A Risky Investment?

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. Importantly, Scandic Hotels Group AB (publ) (STO:SHOT) does carry debt. But the more important question is: how much risk is that debt creating?

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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Scandic Hotels Group

How Much Debt Does Scandic Hotels Group Carry?

You can click the graphic below for the historical numbers, but it shows that Scandic Hotels Group had kr3.21b of debt in September 2022, down from kr5.20b, one year before. However, it does have kr76.0m in cash offsetting this, leading to net debt of about kr3.14b.

How Strong Is Scandic Hotels Group's Balance Sheet?

We can see from the most recent balance sheet that Scandic Hotels Group had liabilities of kr6.77b falling due within a year, and liabilities of kr42.0b due beyond that. On the other hand, it had cash of kr76.0m and kr727.0m worth of receivables due within a year. So its liabilities total kr47.9b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the kr6.85b 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, Scandic Hotels Group 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).

Scandic Hotels Group has a very low debt to EBITDA ratio of 1.00 so it is strange to see weak interest coverage, with last year's EBIT being only 1.3 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. We also note that Scandic Hotels Group improved its EBIT from a last year's loss to a positive kr2.3b. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Scandic Hotels Group 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Scandic Hotels Group actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

On the face of it, Scandic Hotels Group's interest cover left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Scandic Hotels Group's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Scandic Hotels Group , and understanding them should be part of your investment process.

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.