We Think K2A Knaust & Andersson Fastigheter (STO:K2A B) Is Taking Some Risk With Its Debt

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.' 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 can see that K2A Knaust & Andersson Fastigheter AB (publ) (STO:K2A B) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for K2A Knaust & Andersson Fastigheter

How Much Debt Does K2A Knaust & Andersson Fastigheter Carry?

You can click the graphic below for the historical numbers, but it shows that K2A Knaust & Andersson Fastigheter had kr6.35b of debt in June 2024, down from kr7.03b, one year before. However, it does have kr131.9m in cash offsetting this, leading to net debt of about kr6.22b.

A Look At K2A Knaust & Andersson Fastigheter's Liabilities

We can see from the most recent balance sheet that K2A Knaust & Andersson Fastigheter had liabilities of kr2.86b falling due within a year, and liabilities of kr4.56b due beyond that. Offsetting this, it had kr131.9m in cash and kr211.6m in receivables that were due within 12 months. So it has liabilities totalling kr7.07b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the kr1.01b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, K2A Knaust & Andersson Fastigheter would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

K2A Knaust & Andersson Fastigheter shareholders face the double whammy of a high net debt to EBITDA ratio (24.7), and fairly weak interest coverage, since EBIT is just 1.1 times the interest expense. The debt burden here is substantial. Fortunately, K2A Knaust & Andersson Fastigheter grew its EBIT by 7.5% in the last year, slowly shrinking its debt relative to earnings. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if K2A Knaust & Andersson Fastigheter 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, K2A Knaust & Andersson Fastigheter produced sturdy free cash flow equating to 63% 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, K2A Knaust & Andersson Fastigheter's interest cover left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Overall, it seems to us that K2A Knaust & Andersson Fastigheter's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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 3 warning signs for K2A Knaust & Andersson Fastigheter (2 are potentially serious!) that you should be aware of before investing here.

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.