AAK AB (publ.) (STO:AAK) Seems To Use Debt Quite Sensibly

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.' 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. We can see that AAK AB (publ.) (STO:AAK) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.

See our latest analysis for AAK AB (publ.)

How Much Debt Does AAK AB (publ.) Carry?

The image below, which you can click on for greater detail, shows that AAK AB (publ.) had debt of kr5.26b at the end of June 2023, a reduction from kr6.89b over a year. On the flip side, it has kr1.49b in cash leading to net debt of about kr3.77b.

How Strong Is AAK AB (publ.)'s Balance Sheet?

The latest balance sheet data shows that AAK AB (publ.) had liabilities of kr11.3b due within a year, and liabilities of kr4.55b falling due after that. Offsetting this, it had kr1.49b in cash and kr9.73b in receivables that were due within 12 months. So it has liabilities totalling kr4.64b more than its cash and near-term receivables, combined.

Of course, AAK AB (publ.) has a market capitalization of kr51.9b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

AAK AB (publ.) has a low net debt to EBITDA ratio of only 0.91. And its EBIT easily covers its interest expense, being 11.6 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, AAK AB (publ.) grew its EBIT by 39% over the last twelve months, and that growth will make it easier to handle its debt. 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 AAK AB (publ.) 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, AAK AB (publ.)'s free cash flow amounted to 26% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

AAK AB (publ.)'s EBIT growth rate suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. Taking all this data into account, it seems to us that AAK AB (publ.) takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of AAK AB (publ.)'s earnings per share history for free.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.