Is Lyko Group (STO:LYKO A) Using Too Much Debt?

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 note that Lyko Group AB (publ) (STO:LYKO A) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Lyko Group

How Much Debt Does Lyko Group Carry?

As you can see below, at the end of June 2023, Lyko Group had kr204.0m of debt, up from kr134.6m a year ago. Click the image for more detail. On the flip side, it has kr7.60m in cash leading to net debt of about kr196.4m.

How Healthy Is Lyko Group's Balance Sheet?

According to the last reported balance sheet, Lyko Group had liabilities of kr766.2m due within 12 months, and liabilities of kr240.4m due beyond 12 months. Offsetting this, it had kr7.60m in cash and kr64.2m in receivables that were due within 12 months. So it has liabilities totalling kr934.8m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of kr1.44b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

Lyko Group's net debt is sitting at a very reasonable 2.2 times its EBITDA, while its EBIT covered its interest expense just 3.1 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Pleasingly, Lyko Group is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 144% gain in the last twelve months. 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 Lyko Group'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, Lyko Group actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Lyko Group's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its interest cover has the opposite effect. Looking at all the aforementioned factors together, it strikes us that Lyko Group can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. To that end, you should be aware of the 1 warning sign we've spotted with Lyko Group .

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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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.