We Think Telefonaktiebolaget LM Ericsson (STO:ERIC B) Can Stay On Top Of Its Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Telefonaktiebolaget LM Ericsson (publ) (STO:ERIC B) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Telefonaktiebolaget LM Ericsson

How Much Debt Does Telefonaktiebolaget LM Ericsson Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 Telefonaktiebolaget LM Ericsson had kr33.8b of debt, an increase on kr30.0b, over one year. However, it does have kr30.8b in cash offsetting this, leading to net debt of about kr2.99b.

How Strong Is Telefonaktiebolaget LM Ericsson's Balance Sheet?

According to the last reported balance sheet, Telefonaktiebolaget LM Ericsson had liabilities of kr147.7b due within 12 months, and liabilities of kr63.3b due beyond 12 months. Offsetting this, it had kr30.8b in cash and kr84.6b in receivables that were due within 12 months. So it has liabilities totalling kr95.6b more than its cash and near-term receivables, combined.

Telefonaktiebolaget LM Ericsson has a very large market capitalization of kr190.2b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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 debt at a measly 0.097 times EBITDA and EBIT covering interest a whopping 28.8 times, it's clear that Telefonaktiebolaget LM Ericsson is not a desperate borrower. So relative to past earnings, the debt load seems trivial. It is just as well that Telefonaktiebolaget LM Ericsson's load is not too heavy, because its EBIT was down 29% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Telefonaktiebolaget LM Ericsson'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Telefonaktiebolaget LM Ericsson produced sturdy free cash flow equating to 73% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Based on what we've seen Telefonaktiebolaget LM Ericsson is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. Looking at all this data makes us feel a little cautious about Telefonaktiebolaget LM Ericsson's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Telefonaktiebolaget LM Ericsson you should be aware of.

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. 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.