Is K2A Knaust & Andersson Fastigheter (STO:K2A B) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, K2A Knaust & Andersson Fastigheter AB (publ) (STO:K2A B) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for K2A Knaust & Andersson Fastigheter

What Is K2A Knaust & Andersson Fastigheter's Debt?

As you can see below, at the end of December 2020, K2A Knaust & Andersson Fastigheter had kr4.18b of debt, up from kr2.60b a year ago. Click the image for more detail. However, it does have kr412.1m in cash offsetting this, leading to net debt of about kr3.77b.

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

We can see from the most recent balance sheet that K2A Knaust & Andersson Fastigheter had liabilities of kr1.03b falling due within a year, and liabilities of kr3.69b due beyond that. On the other hand, it had cash of kr412.1m and kr13.4m worth of receivables due within a year. So it has liabilities totalling kr4.30b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's kr3.47b 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.

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). 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).

Weak interest cover of 1.6 times and a disturbingly high net debt to EBITDA ratio of 37.3 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. Looking on the bright side, K2A Knaust & Andersson Fastigheter boosted its EBIT by a silky 59% in the last year. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine K2A Knaust & Andersson Fastigheter's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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, K2A Knaust & Andersson Fastigheter produced sturdy free cash flow equating to 51% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

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. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for K2A Knaust & Andersson Fastigheter (of which 2 are a bit concerning!) you should know about.

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. 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.
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