We Think Purefun Group (STO:PURE) Can Stay On Top Of 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 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. Importantly, Purefun Group AB (publ) (STO:PURE) does carry debt. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Purefun Group

What Is Purefun Group's Debt?

You can click the graphic below for the historical numbers, but it shows that Purefun Group had kr23.2m of debt in October 2023, down from kr25.3m, one year before. On the flip side, it has kr13.1m in cash leading to net debt of about kr10.1m.

A Look At Purefun Group's Liabilities

The latest balance sheet data shows that Purefun Group had liabilities of kr18.3m due within a year, and liabilities of kr24.0m falling due after that. Offsetting this, it had kr13.1m in cash and kr7.30m in receivables that were due within 12 months. So its liabilities total kr21.9m more than the combination of its cash and short-term receivables.

Of course, Purefun Group has a market capitalization of kr134.4m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Purefun Group has net debt of just 0.54 times EBITDA, indicating that it is certainly not a reckless borrower. And this view is supported by the solid interest coverage, with EBIT coming in at 9.7 times the interest expense over the last year. Even more impressive was the fact that Purefun Group grew its EBIT by 721% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Purefun Group will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept 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, Purefun Group burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Happily, Purefun Group's impressive EBIT growth rate implies it has the upper hand on its debt. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. All these things considered, it appears that Purefun Group can comfortably handle its current debt levels. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Purefun Group is showing 2 warning signs in our investment analysis , and 1 of those doesn'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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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.