Is Midsummer (STO:MIDS) Using Debt In A Risky Way?

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 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 can see that Midsummer AB (publ) (STO:MIDS) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Midsummer

What Is Midsummer's Net Debt?

As you can see below, Midsummer had kr201.8m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has kr217.6m in cash, leading to a kr15.8m net cash position.

How Strong Is Midsummer's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Midsummer had liabilities of kr55.0m due within 12 months and liabilities of kr209.5m due beyond that. Offsetting this, it had kr217.6m in cash and kr148.7m in receivables that were due within 12 months. So it actually has kr101.8m more liquid assets than total liabilities.

It's good to see that Midsummer has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Midsummer has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Midsummer's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Midsummer had a loss before interest and tax, and actually shrunk its revenue by 52%, to kr96m. That makes us nervous, to say the least.

So How Risky Is Midsummer?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And the fact is that over the last twelve months Midsummer lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of kr133m and booked a kr92m accounting loss. Given it only has net cash of kr15.8m, the company may need to raise more capital if it doesn't reach break-even soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. 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 Midsummer has 3 warning signs (and 2 which are a bit unpleasant) we think you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. 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.
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