Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but the fact that you suffer a permanent loss of capital. “. It’s only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. Like many other companies Borregaard ASA (OB: BRG) uses debt. But does this debt worry shareholders?
When is debt dangerous?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that he must raise new equity at low cost, thereby diluting shareholders over the long term. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
Check out our latest analysis for Borregaard
What is Borregaard’s net debt?
As you can see below, Borregaard was in debt of Kroner 1.45 billion in March 2021, up from Kroner 2.03 billion a year earlier. However, it has 213.0 million kr in cash offsetting this, which leads to a net debt of around 1.23 billion kr.
How strong is Borregaard’s balance sheet?
We can see from the most recent balance sheet that Borregaard had liabilities of 1.36 billion crowns maturing within one year and liabilities of 1.69 billion crowns beyond. In compensation for these obligations, it had cash of 213.0 million kr as well as receivables valued at 1.13 billion kr due within 12 months. Its liabilities therefore total 1.71 billion crowns more than the combination of its cash and short-term receivables.
Given that publicly traded Borregaard shares are worth a total of SEK 18.3 billion, it seems unlikely that this level of liabilities is a major threat. But there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward.
We use two main ratios to tell us about leverage versus earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Borregaard has a low net debt to EBITDA ratio of just 1.1. And its EBIT easily covers its interest costs, being 10.2 times higher. So we’re pretty relaxed about its ultra-conservative use of debt. In fact, Borregaard’s saving grace is its low level of debt, as its EBIT has fallen 57% in the past twelve months. When a business sees its profits widening, it can sometimes see its relationship with its lenders deteriorate. There is no doubt that we learn the most about debt from the balance sheet. But it’s future profits, more than anything, that will determine Borregaard’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 analyst earnings forecast report interesting.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, Borregaard has posted free cash flow of 19% of its EBIT, which is really pretty low. This low level of cash conversion undermines its ability to manage and repay its debts.
Our point of view
Borregaard’s EBIT growth rate was a real negative on this analysis, although other factors we took into account cast it in a significantly better light. In particular, his interest coverage was invigorating. We think Borregaard’s debt makes it a bit risky, having considered the aforementioned data points together. This isn’t necessarily a bad thing, as leverage can increase returns on equity, but it’s something to be aware of. Given our hesitation on the stock, it would be good to know if any Borregaard insiders have sold any shares recently. You click here to see if any insiders have sold recently.
If you are interested in investing in companies that can generate profits without the burden of debt, check out this page free list of growing companies that have net cash on the balance sheet.
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