We Think Svenska Cellulosa Aktiebolaget (STO:SCA B) Can Stay On Top Of Its Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Svenska Cellulosa Aktiebolaget SCA (publ) (STO:SCA B) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Svenska Cellulosa Aktiebolaget

How Much Debt Does Svenska Cellulosa Aktiebolaget Carry?

As you can see below, at the end of March 2022, Svenska Cellulosa Aktiebolaget had kr9.78b of debt, up from kr9.20b a year ago. Click the image for more detail. However, it also had kr1.16b in cash, and so its net debt is kr8.61b.

How Healthy Is Svenska Cellulosa Aktiebolaget's Balance Sheet?

The latest balance sheet data shows that Svenska Cellulosa Aktiebolaget had liabilities of kr9.53b due within a year, and liabilities of kr28.5b falling due after that. On the other hand, it had cash of kr1.16b and kr3.86b worth of receivables due within a year. So its liabilities total kr33.0b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Svenska Cellulosa Aktiebolaget is worth a massive kr114.1b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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

Svenska Cellulosa Aktiebolaget's net debt is only 1.0 times its EBITDA. And its EBIT easily covers its interest expense, being 82.6 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Even more impressive was the fact that Svenska Cellulosa Aktiebolaget grew its EBIT by 628% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Svenska Cellulosa Aktiebolaget'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, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Svenska Cellulosa Aktiebolaget recorded free cash flow of 28% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Svenska Cellulosa Aktiebolaget's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. Looking at all the aforementioned factors together, it strikes us that Svenska Cellulosa Aktiebolaget can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Svenska Cellulosa Aktiebolaget (1 is a bit concerning!) that you should be aware of before investing here.

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.