Castellum (STO:CAST) Has A Somewhat Strained Balance Sheet

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.' 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 Castellum AB (publ) (STO:CAST) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Castellum

What Is Castellum's Debt?

You can click the graphic below for the historical numbers, but it shows that Castellum had kr59.7b of debt in September 2024, down from kr65.9b, one year before. However, it does have kr1.83b in cash offsetting this, leading to net debt of about kr57.9b.

A Look At Castellum's Liabilities

According to the last reported balance sheet, Castellum had liabilities of kr17.1b due within 12 months, and liabilities of kr62.1b due beyond 12 months. On the other hand, it had cash of kr1.83b and kr1.61b worth of receivables due within a year. So it has liabilities totalling kr75.8b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of kr63.3b, we think shareholders really should watch Castellum's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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.

Castellum shareholders face the double whammy of a high net debt to EBITDA ratio (8.4), and fairly weak interest coverage, since EBIT is just 2.1 times the interest expense. The debt burden here is substantial. Notably, Castellum's EBIT was pretty flat over the last year, which isn't ideal given the debt load. 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 Castellum's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Castellum produced sturdy free cash flow equating to 59% 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

On the face of it, Castellum's interest cover left us tentative about the stock, and its net debt to EBITDA was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Looking at the bigger picture, it seems clear to us that Castellum's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Castellum that you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.