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.' 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. Importantly, Luka Koper d.d. (LJSE:LKPG) does carry debt. But is this debt a concern to shareholders?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for Luka Koper d.d
What Is Luka Koper d.d's Debt?
As you can see below, Luka Koper d.d had €83.8m of debt at September 2020, down from €96.0m a year prior. On the flip side, it has €69.4m in cash leading to net debt of about €14.4m.
How Healthy Is Luka Koper d.d's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Luka Koper d.d had liabilities of €59.5m due within 12 months and liabilities of €119.8m due beyond that. Offsetting these obligations, it had cash of €69.4m as well as receivables valued at €40.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €69.8m.
While this might seem like a lot, it is not so bad since Luka Koper d.d has a market capitalization of €275.8m, and so it could probably strengthen its balance sheet by raising capital if it needed to. 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.
Luka Koper d.d has a low debt to EBITDA ratio of only 0.26. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So it's fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. It is just as well that Luka Koper d.d's load is not too heavy, because its EBIT was down 42% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Luka Koper d.d'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Luka Koper d.d generated free cash flow amounting to a very robust 93% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
Our View
Happily, Luka Koper d.d's impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its EBIT growth rate. We would also note that Infrastructure industry companies like Luka Koper d.d commonly do use debt without problems. Looking at all the aforementioned factors together, it strikes us that Luka Koper d.d can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. To that end, you should be aware of the 1 warning sign we've spotted with Luka Koper d.d .
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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About LJSE:LKPG
Luka Koper d.d
Provides seaport and logistics system services in the Port of Koper located in Slovenia.
Flawless balance sheet average dividend payer.