Swedish Orphan Biovitrum (STO:SOBI) Seems To Use Debt Quite Sensibly
Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, Swedish Orphan Biovitrum AB (publ) (STO:SOBI) does carry debt. But the more important question is: how much risk is that debt creating?
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for Swedish Orphan Biovitrum
What Is Swedish Orphan Biovitrum's Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2023 Swedish Orphan Biovitrum had kr20.2b of debt, an increase on kr8.77b, over one year. However, because it has a cash reserve of kr904.0m, its net debt is less, at about kr19.3b.
How Healthy Is Swedish Orphan Biovitrum's Balance Sheet?
The latest balance sheet data shows that Swedish Orphan Biovitrum had liabilities of kr19.1b due within a year, and liabilities of kr21.1b falling due after that. Offsetting this, it had kr904.0m in cash and kr7.89b in receivables that were due within 12 months. So its liabilities total kr31.4b more than the combination of its cash and short-term receivables.
Swedish Orphan Biovitrum has a market capitalization of kr89.1b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).
Swedish Orphan Biovitrum has net debt worth 2.5 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 4.1 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Importantly Swedish Orphan Biovitrum's EBIT was essentially flat over the last twelve months. Ideally it can diminish its debt load by kick-starting earnings growth. 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 Swedish Orphan Biovitrum can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Swedish Orphan Biovitrum produced sturdy free cash flow equating to 61% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Our View
When it comes to the balance sheet, the standout positive for Swedish Orphan Biovitrum was the fact that it seems able to convert EBIT to free cash flow confidently. However, our other observations weren't so heartening. For instance it seems like it has to struggle a bit to cover its interest expense with its EBIT. When we consider all the factors mentioned above, we do feel a bit cautious about Swedish Orphan Biovitrum's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with Swedish Orphan Biovitrum .
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.
About OM:SOBI
Swedish Orphan Biovitrum
An integrated biotechnology company, researches, develops, manufactures, and sells pharmaceuticals in the therapeutic areas of haematology, immunology, and specialty care in Europe, North America, the Middle East, Asia, and Australia.
Good value with proven track record.