Is HEXPOL (STO:HPOL B) A Risky Investment?

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.' 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 the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for HEXPOL

What Is HEXPOL's Debt?

You can click the graphic below for the historical numbers, but it shows that HEXPOL had kr3.06b of debt in September 2023, down from kr4.03b, one year before. However, it also had kr1.29b in cash, and so its net debt is kr1.77b.

How Strong Is HEXPOL's Balance Sheet?

We can see from the most recent balance sheet that HEXPOL had liabilities of kr6.48b falling due within a year, and liabilities of kr2.53b due beyond that. Offsetting these obligations, it had cash of kr1.29b as well as receivables valued at kr3.68b due within 12 months. So it has liabilities totalling kr4.04b more than its cash and near-term receivables, combined.

Of course, HEXPOL has a market capitalization of kr40.3b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). 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 has a low net debt to EBITDA ratio of only 0.43. And its EBIT easily covers its interest expense, being 15.8 times the size. So we're pretty relaxed about its super-conservative use of debt. And we also note warmly that HEXPOL grew its EBIT by 18% last year, making its debt load easier to handle. 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 HEXPOL can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, HEXPOL produced sturdy free cash flow equating to 70% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, HEXPOL's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its net debt to EBITDA also supports that impression! Zooming out, HEXPOL seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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.