Is Embracer Group (STO:EMBRAC B) Using Too Much Debt?

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. We can see that Embracer Group AB (publ) (STO:EMBRAC B) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Embracer Group

What Is Embracer Group's Net Debt?

The chart below, which you can click on for greater detail, shows that Embracer Group had kr1.49b in debt in March 2021; about the same as the year before. But it also has kr14.3b in cash to offset that, meaning it has kr12.8b net cash.

How Healthy Is Embracer Group's Balance Sheet?

According to the last reported balance sheet, Embracer Group had liabilities of kr3.52b due within 12 months, and liabilities of kr3.06b due beyond 12 months. Offsetting these obligations, it had cash of kr14.3b as well as receivables valued at kr2.01b due within 12 months. So it can boast kr9.72b more liquid assets than total liabilities.

This short term liquidity is a sign that Embracer Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Embracer Group boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Embracer Group saw its EBIT decline by 4.7% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Embracer Group 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Embracer Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Embracer Group actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company's debt, in this case Embracer Group has kr12.8b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of kr1.7b, being 113% of its EBIT. So we don't think Embracer Group's use of debt is risky. 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 example, we've discovered 2 warning signs for Embracer Group that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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