Does K2A Knaust & Andersson Fastigheter (STO:K2A B) Have A Healthy Balance Sheet?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that K2A Knaust & Andersson Fastigheter AB (publ) (STO:K2A B) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

Check out our latest analysis for K2A Knaust & Andersson Fastigheter

What Is K2A Knaust & Andersson Fastigheter's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 K2A Knaust & Andersson Fastigheter had kr3.71b of debt, an increase on kr2.52b, over one year. On the flip side, it has kr394.0m in cash leading to net debt of about kr3.31b.

How Healthy Is K2A Knaust & Andersson Fastigheter's Balance Sheet?

According to the last reported balance sheet, K2A Knaust & Andersson Fastigheter had liabilities of kr962.1m due within 12 months, and liabilities of kr3.24b due beyond 12 months. Offsetting this, it had kr394.0m in cash and kr60.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr3.75b.

When you consider that this deficiency exceeds the company's kr2.75b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 1.6 times and a disturbingly high net debt to EBITDA ratio of 35.2 hit our confidence in K2A Knaust & Andersson Fastigheter like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. The good news is that K2A Knaust & Andersson Fastigheter grew its EBIT a smooth 65% over the last twelve months. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. 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 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. During the last three years, K2A Knaust & Andersson Fastigheter 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, K2A Knaust & Andersson Fastigheter'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 EBIT growth rate is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that K2A Knaust & Andersson Fastigheter's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less 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. To that end, you should learn about the 4 warning signs we've spotted with K2A Knaust & Andersson Fastigheter (including 2 which is are significant) .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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