We Think Fastighets AB Trianon (STO:TRIAN B) Is Taking Some Risk With Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Fastighets AB Trianon (publ) (STO:TRIAN B) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Fastighets AB Trianon

How Much Debt Does Fastighets AB Trianon Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Fastighets AB Trianon had debt of kr5.55b, up from kr4.47b in one year. On the flip side, it has kr163.7m in cash leading to net debt of about kr5.39b.

A Look At Fastighets AB Trianon's Liabilities

We can see from the most recent balance sheet that Fastighets AB Trianon had liabilities of kr192.3m falling due within a year, and liabilities of kr6.26b due beyond that. On the other hand, it had cash of kr163.7m and kr75.0m worth of receivables due within a year. So its liabilities total kr6.22b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of kr5.04b, we think shareholders really should watch Fastighets AB Trianon's debt levels, like a parent watching their child ride a bike for the first time. 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).

Fastighets AB Trianon shareholders face the double whammy of a high net debt to EBITDA ratio (17.8), and fairly weak interest coverage, since EBIT is just 1.8 times the interest expense. The debt burden here is substantial. The good news is that Fastighets AB Trianon grew its EBIT a smooth 33% 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. 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 Fastighets AB Trianon's ability to maintain a healthy balance sheet going forward. 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Fastighets AB Trianon produced sturdy free cash flow equating to 65% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Neither Fastighets AB Trianon's ability handle its debt, based on its EBITDA, nor its interest cover gave us confidence in its ability to take on more debt. But the good news is it seems to be able to grow its EBIT with ease. Taking the abovementioned factors together we do think Fastighets AB Trianon's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 4 warning signs for Fastighets AB Trianon you should be aware of, and 2 of them are a bit concerning.

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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