David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Like many other companies Enea AB (publ) (STO:ENEA) uses debt. But the more important question is: what risk does this debt create?
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. If things go really bad, lenders can take over the business. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.
See our latest analysis for Enea
What is Enea’s debt?
The image below, which you can click on for more details, shows that in March 2022, Enea had a debt of 697.0 million kr, compared to 438.1 million kr in one year. However, as he has a cash reserve of 142.5 million kr, his net debt is lower at around 554.5 million kr.
A look at Enea’s responsibilities
We can see from the most recent balance sheet that Enea had liabilities of 580.3 million kr due in one year, and liabilities of 646.1 million kr due beyond. On the other hand, it had cash of 142.5 million kr and 505.4 million kr of receivables due within one year. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of 578.5 million kr.
Enea has a market capitalization of 2.21 billion kr, so it could very likely raise funds to improve its balance sheet, should the need arise. However, it is always worth taking a close look at its ability to repay debt.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). Thus, we consider debt to earnings with and without amortization and depreciation expense.
We would say that Enea’s moderate net debt/EBITDA ratio (2.3) indicates prudence in terms of debt. And its towering EBIT of 15.1 times its interest expense means that the debt burden is as light as a peacock feather. The bad news is that Enea saw its EBIT fall by 11% compared to last year. If that kind of decline isn’t stopped, then managing his debt will be harder than selling broccoli-flavored ice cream for a bounty. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine Enea’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 earnings forecast report interesting.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Enea has recorded free cash flow representing 67% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This cold hard cash allows him to reduce his debt whenever he wants.
Our point of view
According to our analysis, Enea’s interest coverage should signal that it will not have too many problems with its debt. But the other factors we noted above weren’t so encouraging. For example, it looks like it has to struggle a bit to increase its EBIT. When we consider all the elements mentioned above, it seems to us that Enea manages its debt quite well. That said, the charge is heavy enough that we recommend that any shareholder keep a close eye on it. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 1 warning sign for Enea you should know.
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.