HEXPOL (STO:HPOL B) Has A Rock Solid Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. Importantly, HEXPOL AB (publ) (STO:HPOL B) does carry debt. But is this debt a concern to shareholders?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for HEXPOL

What Is HEXPOL's Debt?

The image below, which you can click on for greater detail, shows that at March 2023 HEXPOL had debt of kr3.51b, up from kr2.28b in one year. However, it does have kr1.45b in cash offsetting this, leading to net debt of about kr2.06b.

How Healthy Is HEXPOL's Balance Sheet?

According to the last reported balance sheet, HEXPOL had liabilities of kr7.64b due within 12 months, and liabilities of kr1.89b due beyond 12 months. On the other hand, it had cash of kr1.45b and kr3.88b worth of receivables due within a year. So it has liabilities totalling kr4.20b more than its cash and near-term receivables, combined.

Given HEXPOL has a market capitalization of kr38.2b, 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).

HEXPOL's net debt is only 0.53 times its EBITDA. And its EBIT covers its interest expense a whopping 26.3 times over. So we're pretty relaxed about its super-conservative use of debt. Also positive, HEXPOL grew its EBIT by 23% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine HEXPOL's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, HEXPOL produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

The good news is that HEXPOL's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Overall, we don't think HEXPOL is taking any bad risks, as its debt load seems modest. So we're not worried about the use of a little leverage on the balance sheet. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check HEXPOL's dividend history, without delay!

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.