Does AAK AB (publ.) (STO:AAK) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies AAK AB (publ.) (STO:AAK) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for AAK AB (publ.)

What Is AAK AB (publ.)'s Net Debt?

The image below, which you can click on for greater detail, shows that AAK AB (publ.) had debt of kr2.68b at the end of September 2024, a reduction from kr4.28b over a year. However, because it has a cash reserve of kr1.26b, its net debt is less, at about kr1.42b.

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

We can see from the most recent balance sheet that AAK AB (publ.) had liabilities of kr10.9b falling due within a year, and liabilities of kr2.67b due beyond that. On the other hand, it had cash of kr1.26b and kr8.78b worth of receivables due within a year. So it has liabilities totalling kr3.57b more than its cash and near-term receivables, combined.

Given AAK AB (publ.) has a market capitalization of kr82.6b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

AAK AB (publ.) has a low net debt to EBITDA ratio of only 0.26. And its EBIT easily covers its interest expense, being 29.6 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Another good sign is that AAK AB (publ.) has been able to increase its EBIT by 27% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, AAK AB (publ.)'s free cash flow amounted to 37% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Happily, AAK AB (publ.)'s impressive interest cover implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. Zooming out, AAK AB (publ.) seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. Over time, share prices tend to follow earnings per share, so if you're interested in AAK AB (publ.), you may well want to click here to check an interactive graph of its earnings per share history.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.