These 4 Measures Indicate That Acrinova (STO:ACRI A) Is Using Debt Extensively

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. As with many other companies Acrinova AB (publ) (STO:ACRI A) makes use of debt. But the real question is whether this debt is making the company risky.

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Acrinova

What Is Acrinova's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 Acrinova had kr927.9m of debt, an increase on kr676.6m, over one year. However, because it has a cash reserve of kr83.7m, its net debt is less, at about kr844.2m.

How Healthy Is Acrinova's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Acrinova had liabilities of kr201.5m due within 12 months and liabilities of kr878.2m due beyond that. Offsetting these obligations, it had cash of kr83.7m as well as receivables valued at kr45.5m due within 12 months. So its liabilities total kr950.5m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the kr488.3m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Acrinova would likely require a major re-capitalisation if it had to pay its creditors today.

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).

Acrinova shareholders face the double whammy of a high net debt to EBITDA ratio (17.1), and fairly weak interest coverage, since EBIT is just 2.3 times the interest expense. This means we'd consider it to have a heavy debt load. On a slightly more positive note, Acrinova grew its EBIT at 19% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Acrinova's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Acrinova recorded free cash flow worth 71% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

On the face of it, Acrinova's net debt to EBITDA 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 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 Acrinova's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. To that end, you should learn about the 5 warning signs we've spotted with Acrinova (including 1 which is a bit unpleasant) .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.