Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘Volatility is far from synonymous with risk.’ So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Epiroc AB (publ) (STO:EPI A) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first step when considering a company’s debt levels is to consider its cash and debt together.
How Much Debt Does Epiroc Carry?
As you can see below, Epiroc had kr9.32b of debt at March 2022, down from kr10.1b a year prior. But it also has kr11.2b in cash to offset that, meaning it has kr1.89b net cash.
How Strong Is Epiroc’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Epiroc had liabilities of kr13.5b due within 12 months and liabilities of kr10.1b due beyond that. Offsetting this, it had kr11.2b in cash and kr10.8b in receivables that were due within 12 months. So it has liabilities totalling kr1.56b more than its cash and near-term receivables, combined.
This state of affairs indicates that Epiroc’s balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it’s hard to imagine that the kr211.6b company is struggling for cash, we still think it’s worth monitoring its balance sheet. While it does have liabilities worth noting, Epiroc also has more cash than debt, so we’re pretty confident it can manage its debt safely.
Another good sign is that Epiroc has been able to increase its EBIT by 28% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Epiroc’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 report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Epiroc may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Epiroc recorded free cash flow worth a fulsome 80% of its EBIT, which is stronger than we’d usually expect. That puts it in a very strong position to pay down debt.
While it is always sensible to look at a company’s total liabilities, it is very reassuring that Epiroc has kr1.89b in net cash. The cherry on top was that in converted 80% of that EBIT to free cash flow, bringing in kr5.6b. So we don’t think Epiroc’s use of debt is risky. 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. For example, we’ve discovered 1 warning sign for Epiroc that you should be aware of before investing here.
When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.