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

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Lyko Group AB (publ) (STO:LYKO A) does carry debt. But should shareholders be worried about its use of debt?

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When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

What Is Lyko Group's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2024 Lyko Group had kr473.6m of debt, an increase on kr297.5m, over one year. However, it also had kr140.5m in cash, and so its net debt is kr333.1m.

How Healthy Is Lyko Group's Balance Sheet?

The latest balance sheet data shows that Lyko Group had liabilities of kr1.03b due within a year, and liabilities of kr817.0m falling due after that. On the other hand, it had cash of kr140.5m and kr101.5m worth of receivables due within a year. So its liabilities total kr1.60b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of kr1.94b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

Check out our latest analysis for Lyko Group

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). 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).

While Lyko Group has a quite reasonable net debt to EBITDA multiple of 2.4, its interest cover seems weak, at 1.4. This does suggest the company is paying fairly high interest rates. In any case, it's safe to say the company has meaningful debt. Pleasingly, Lyko Group is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 136% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Lyko Group 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 last three years, Lyko Group reported free cash flow worth 19% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Neither Lyko Group's ability to cover its interest expense with its EBIT nor its level of total liabilities gave us confidence in its ability to take on more debt. But its EBIT growth rate tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think Lyko Group's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Lyko Group (1 is a bit unpleasant!) that you should be aware of before investing here.

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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.