Here's Why K-Fast Holding (STO:KFAST B) Can Manage Its Debt Responsibly

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.' 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. We can see that K-Fast Holding AB (publ) (STO:KFAST B) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for K-Fast Holding

What Is K-Fast Holding's Debt?

As you can see below, at the end of December 2021, K-Fast Holding had kr5.94b of debt, up from kr3.86b a year ago. Click the image for more detail. Net debt is about the same, since the it doesn't have much cash.

How Healthy Is K-Fast Holding's Balance Sheet?

According to the last reported balance sheet, K-Fast Holding had liabilities of kr1.44b due within 12 months, and liabilities of kr5.81b due beyond 12 months. Offsetting this, it had kr94.0m in cash and kr312.9m in receivables that were due within 12 months. So it has liabilities totalling kr6.84b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since K-Fast Holding has a market capitalization of kr14.2b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without 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.

K-Fast Holding shareholders face the double whammy of a high net debt to EBITDA ratio (25.9), and fairly weak interest coverage, since EBIT is just 2.4 times the interest expense. The debt burden here is substantial. The good news is that K-Fast Holding grew its EBIT a smooth 69% over the last twelve months. 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 ultimately the future profitability of the business will decide if K-Fast Holding can strengthen its balance sheet over time. 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, K-Fast Holding recorded free cash flow worth 61% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

K-Fast Holding's net debt to EBITDA was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its EBIT growth rate. Looking at all this data makes us feel a little cautious about K-Fast Holding's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. Case in point: We've spotted 5 warning signs for K-Fast Holding you should be aware of, and 2 of them are a bit concerning.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.