Here's Why Ayima Group (STO:AYIMA B) Can Manage Its Debt Responsibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We note that Ayima Group AB (publ) (STO:AYIMA B) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Ayima Group

What Is Ayima Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Ayima Group had kr15.6m of debt, an increase on kr14.4m, over one year. On the flip side, it has kr7.59m in cash leading to net debt of about kr8.01m.

How Strong Is Ayima Group's Balance Sheet?

We can see from the most recent balance sheet that Ayima Group had liabilities of kr43.3m falling due within a year, and liabilities of kr14.5m due beyond that. On the other hand, it had cash of kr7.59m and kr21.6m worth of receivables due within a year. So it has liabilities totalling kr28.6m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Ayima Group is worth kr91.1m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without 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).

Ayima Group has a very low debt to EBITDA ratio of 0.48 so it is strange to see weak interest coverage, with last year's EBIT being only 1.2 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. Notably, Ayima Group made a loss at the EBIT level, last year, but improved that to positive EBIT of kr4.7m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Ayima Group's earnings that will influence how the balance sheet holds up in the future. 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 it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Happily for any shareholders, Ayima Group actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Based on what we've seen Ayima Group is not finding it easy, given its interest cover, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to convert EBIT to free cash flow is pretty flash. Considering this range of data points, we think Ayima Group is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Ayima Group , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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