NP3 Fastigheter (STO:NP3) Has A Somewhat Strained Balance Sheet

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.' 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 note that NP3 Fastigheter AB (publ) (STO:NP3) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for NP3 Fastigheter

What Is NP3 Fastigheter's Net Debt?

As you can see below, at the end of September 2020, NP3 Fastigheter had kr7.71b of debt, up from kr6.81b a year ago. Click the image for more detail. However, it does have kr560.0m in cash offsetting this, leading to net debt of about kr7.15b.

How Strong Is NP3 Fastigheter's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that NP3 Fastigheter had liabilities of kr671.0m due within 12 months and liabilities of kr7.96b due beyond that. On the other hand, it had cash of kr560.0m and kr54.0m worth of receivables due within a year. So its liabilities total kr8.01b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's kr6.59b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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

With a net debt to EBITDA ratio of 9.5, it's fair to say NP3 Fastigheter does have a significant amount of debt. However, its interest coverage of 3.9 is reasonably strong, which is a good sign. However, one redeeming factor is that NP3 Fastigheter grew its EBIT at 14% over the last 12 months, boosting its ability to handle 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 NP3 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, NP3 Fastigheter recorded free cash flow worth 62% 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

We'd go so far as to say NP3 Fastigheter's net debt to EBITDA was disappointing. 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 balance sheet and taking into account all these factors, we do believe that debt is making NP3 Fastigheter stock 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. To that end, you should learn about the 4 warning signs we've spotted with NP3 Fastigheter (including 2 which don't sit too well with us) .

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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