Howard Marks put it well when he said that, rather than worrying about stock price volatility, “The possibility of permanent loss is the risk that worries me … and every investor practices that I know is worried “. When we think about how risky a business is, we always like to look at its use of debt because over-indebtedness can lead to bankruptcy. We can see that Kemira Oyj (HEL: KEMIRA) uses debt in his business. But the real question is whether this debt makes the business risky.
When Is Debt a Problem?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. If things really go wrong, lenders can take over the business. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. 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 Kemira Oyj
What is Kemira Oyj’s net debt?
The graph below, which you can click for more details, shows that Kemira Oyj had 858.4 million euros in debt as of March 2021; about the same as the year before. However, he also had â¬ 203.0 million in cash, so his net debt is â¬ 655.4 million.
How strong is Kemira Oyj’s balance sheet?
We can see from the most recent balance sheet that Kemira Oyj had a liability of â¬ 715.5 million due within one year and a liability of â¬ 1.02 billion due beyond. In return, he had â¬ 203.0 million in cash and â¬ 398.0 million in receivables due within 12 months. Its liabilities thus exceed the sum of its cash and its receivables (short term) by 1.13 billion euros.
While that might sound like a lot, it’s not so bad since Kemira Oyj has a market cap of 2.05 billion euros, and could therefore likely strengthen her balance sheet by raising capital if needed. But it is clear that it is absolutely necessary to take a close look at whether it can manage its debt without dilution.
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.
With a debt to EBITDA ratio of 1.7, Kemira Oyj uses debt smartly but responsibly. And the attractive interest coverage (EBIT of 8.0 times the interest costs) certainly does do not do everything to dispel this impression. Notably, Kemira Oyj’s EBIT has been quite stable over the past year. Ideally, he can reduce his debt load by starting profit growth. There is no doubt that we learn the most about debt from the balance sheet. But it’s future earnings, more than anything, that will determine Kemira Oyj’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.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Kemira Oyj has recorded free cash flow of 68% of its EBIT, which is close to normal given that free cash flow excludes interest and taxes. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
Kemira Oyj’s ability to convert EBIT into free cash flow and her interest coverage have bolstered us in her ability to manage her debt. That said, its level of total liabilities does make us somewhat aware of potential future risks to the balance sheet. When we consider all the elements mentioned above, it seems to us that Kemira Oyj is managing her debt quite well. That said, the load is heavy enough that we recommend that any shareholder watch it closely. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. For example, we have identified 1 warning sign for Kemira Oyj of which you should be aware.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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