Warren Buffett said: “Volatility is far from synonymous with risk”. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We notice that Fjord1 ASA (OB: FJORD) has a debt on its balance sheet. But the most important question is: what risk does this debt create?
What risk does debt entail?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, many companies use debt to finance their growth without negative consequences. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
See our latest review for Fjord1
What is Fjord1’s debt?
As you can see below, Fjord1 had a debt of 5.53 billion kr in March 2021, up from 6.22 billion kr a year earlier. On the other hand, he has 128.5 million kr in cash, resulting in net debt of around 5.40 billion kr.
Is Fjord1’s track record healthy?
Zooming in on the latest balance sheet data, we can see that Fjord1 had a liability of SEK 1.80 billion due within 12 months and a liability of SEK 5.72 billion beyond. On the other hand, he had cash of kr 128.5 million and kr 614.0 million of receivables due within one year. Its liabilities therefore total 6.77 billion crowns more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the kr4.34b company itself, as if a child struggles under the weight of a huge backpack full of books, his sports equipment, and a trumpet. So we would be watching its record closely, without a doubt. After all, Fjord1 would likely need a major recapitalization if it were to pay its creditors today.
We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Fjord1 has a fairly high debt to EBITDA ratio of 5.3 which suggests significant leverage. But the good news is that he enjoys a pretty heartwarming 2.7 times interest coverage, which suggests he can meet his obligations responsibly. Looking on the bright side, Fjord1 increased its EBIT by a silky 31% last year. Like a mother’s loving embrace of a newborn, this type of growth builds resilience, putting the business in a stronger position to manage debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future profits, more than anything, that will determine Fjord1’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free Analyst Profit Forecast report interesting.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. We must therefore clearly verify whether this EBIT generates a corresponding free cash flow. Over the past three years, Fjord1 has recorded significant negative free cash flow overall. While this may be the result of spending on growth, it makes debt much riskier.
Our point of view
To be frank, Fjord1’s total liability level and track record of converting EBIT to free cash flow makes us rather uncomfortable with its debt levels. But at least it’s decent enough to increase your EBIT; it’s encouraging. We’re pretty clear that we consider Fjord1 to be really quite risky, due to the health of its balance sheet. We are therefore almost as wary of this stock as a hungry kitten falls into its owner’s fish pond: once bitten, twice shy, as they say. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 2 warning signs for Fjord1 (1 of which should not be ignored!) that you should know.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash-flow-growing stocks today.
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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in the mentioned stocks.
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