Is Ependion (STO:EPEN) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Ependion AB (STO:EPEN) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Ependion

What Is Ependion's Net Debt?

As you can see below, at the end of June 2023, Ependion had kr778.6m of debt, up from kr720.6m a year ago. Click the image for more detail. However, it does have kr160.0m in cash offsetting this, leading to net debt of about kr618.6m.

A Look At Ependion's Liabilities

The latest balance sheet data shows that Ependion had liabilities of kr811.7m due within a year, and liabilities of kr797.7m falling due after that. Offsetting this, it had kr160.0m in cash and kr536.8m in receivables that were due within 12 months. So it has liabilities totalling kr912.6m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Ependion is worth kr3.65b, 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 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With a debt to EBITDA ratio of 1.9, Ependion uses debt artfully but responsibly. And the fact that its trailing twelve months of EBIT was 8.9 times its interest expenses harmonizes with that theme. Pleasingly, Ependion is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 138% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Ependion 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 always check how much of that EBIT is translated into free cash flow. In the last three years, Ependion's free cash flow amounted to 29% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Happily, Ependion's impressive EBIT growth rate implies it has the upper hand on its debt. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. Looking at all the aforementioned factors together, it strikes us that Ependion can handle its debt fairly comfortably. 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. However, not all investment risk resides within the balance sheet - far from it. For example - Ependion has 2 warning signs we think you should be aware of.

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.