These 4 Measures Indicate That New Nordic Healthbrands (STO:NNH) Is Using Debt Reasonably Well

Simply Wall St
October 29, 2021
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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.' 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 can see that New Nordic Healthbrands AB (publ) (STO:NNH) does use debt in its business. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 New Nordic Healthbrands

How Much Debt Does New Nordic Healthbrands Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 New Nordic Healthbrands had kr15.4m of debt, an increase on kr12.5m, over one year. However, it does have kr11.0m in cash offsetting this, leading to net debt of about kr4.36m.

OM:NNH Debt to Equity History October 30th 2021

How Strong Is New Nordic Healthbrands' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that New Nordic Healthbrands had liabilities of kr114.2m due within 12 months and liabilities of kr5.06m due beyond that. Offsetting these obligations, it had cash of kr11.0m as well as receivables valued at kr124.1m due within 12 months. So it can boast kr15.9m more liquid assets than total liabilities.

This surplus suggests that New Nordic Healthbrands has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Carrying virtually no net debt, New Nordic Healthbrands has a very light debt load indeed.

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.

New Nordic Healthbrands's net debt is only 0.12 times its EBITDA. And its EBIT covers its interest expense a whopping 133 times over. So we're pretty relaxed about its super-conservative use of debt. Also good is that New Nordic Healthbrands grew its EBIT at 12% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since New Nordic Healthbrands will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, New Nordic Healthbrands's free cash flow amounted to 34% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

The good news is that New Nordic Healthbrands's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. When we consider the range of factors above, it looks like New Nordic Healthbrands is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. 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. For instance, we've identified 2 warning signs for New Nordic Healthbrands that you should be aware of.

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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