We Think Elekta (STO:EKTA B) Is Taking Some Risk With Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Elekta AB (publ) (STO:EKTA B) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Elekta

What Is Elekta's Debt?

As you can see below, at the end of July 2024, Elekta had kr6.49b of debt, up from kr5.80b a year ago. Click the image for more detail. However, it also had kr2.36b in cash, and so its net debt is kr4.13b.

How Healthy Is Elekta's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Elekta had liabilities of kr14.2b due within 12 months and liabilities of kr6.55b due beyond that. Offsetting this, it had kr2.36b in cash and kr8.15b in receivables that were due within 12 months. So it has liabilities totalling kr10.2b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Elekta has a market capitalization of kr24.2b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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).

Elekta's net debt is sitting at a very reasonable 1.7 times its EBITDA, while its EBIT covered its interest expense just 5.8 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. The bad news is that Elekta saw its EBIT decline by 10% over the last year. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Elekta 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Elekta reported free cash flow worth 19% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

While Elekta's conversion of EBIT to free cash flow makes us cautious about it, its track record of (not) growing its EBIT is no better. But its not so bad at managing its debt, based on its EBITDA,. We should also note that Medical Equipment industry companies like Elekta commonly do use debt without problems. When we consider all the factors discussed, it seems to us that Elekta is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Elekta that 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.