Here's Why Prevas (STO:PREV B) Can Manage Its Debt Responsibly

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Prevas AB (STO:PREV B) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Prevas

How Much Debt Does Prevas Carry?

You can click the graphic below for the historical numbers, but it shows that Prevas had kr84.4m of debt in September 2023, down from kr92.9m, one year before. However, its balance sheet shows it holds kr101.5m in cash, so it actually has kr17.1m net cash.

A Look At Prevas' Liabilities

We can see from the most recent balance sheet that Prevas had liabilities of kr309.7m falling due within a year, and liabilities of kr71.7m due beyond that. On the other hand, it had cash of kr101.5m and kr389.4m worth of receivables due within a year. So it can boast kr109.5m more liquid assets than total liabilities.

This surplus suggests that Prevas has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Prevas has more cash than debt is arguably a good indication that it can manage its debt safely.

Fortunately, Prevas grew its EBIT by 2.8% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Prevas's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Prevas may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, Prevas recorded free cash flow of 42% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Prevas has kr17.1m in net cash and a decent-looking balance sheet. And it also grew its EBIT by 2.8% over the last year. So we are not troubled with Prevas's debt use. 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. Case in point: We've spotted 1 warning sign for Prevas you should be aware of.

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. 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.