Howard Marks put it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Like many other companies SSAB AB (released) (STO: SSAB A) uses debt. But should shareholders be concerned about its use of debt?
When is debt dangerous?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. If things really go wrong, lenders can take over the business. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first step in examining a business’s debt levels is to consider its cash flow and debt together.
Check out our latest analysis for SSAB
What is SSAB’s debt?
The image below, which you can click for more details, shows SSAB owed KKr 11.1 billion in debt at the end of September 2021, down from KKr 16.3 billion year-over-year. . However, because he has a cash reserve of KKr 9.59 billion, his net debt is less, at around KKr 1.51 billion.
A look at the responsibilities of SSAB
According to the last published balance sheet, SSAB had liabilities of KKr 25.3 billion due within 12 months and liabilities of KKr 12.8 billion due beyond 12 months. In return, he had 9.59 billion kr in cash and 13.5 billion kr in receivables due within 12 months. Thus, its liabilities exceed the sum of its cash and (short-term) receivables by 15.1 billion crowns.
While this may sound like a lot, it is not that big of a deal since SSAB has a market cap of Kroner 49.7 billion, and could therefore likely strengthen its 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 use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its earnings before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). Thus, we look at debt versus earnings with and without amortization expenses.
SSAB’s net debt is only 0.10 times its EBITDA. And its EBIT easily covers its interest costs, being 32.5 times higher. So we’re pretty relaxed about its ultra-conservative use of debt. It was also good to see that despite losing money on the EBIT line last year, SSAB has been a game changer over the past 12 months, delivering EBIT of kr 12 billion. When analyzing debt levels, the balance sheet is the obvious place to start. But it is future profits, more than anything, that will determine SSAB’s ability to maintain a healthy balance sheet going forward. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. It is therefore important to check to what extent its earnings before interest and taxes (EBIT) are converted into actual free cash flow. Over the past year, SSAB recorded free cash flow totaling 84% of its EBIT, which is higher than what we usually expected. This positions it well to repay debt if it is desirable.
Our point of view
Fortunately, SSAB’s impressive interest coverage means it has the upper hand on its debt. And this is only the beginning of good news as its conversion from EBIT to free cash flow is also very encouraging. When we consider the range of factors above, it looks like SSAB is being pretty reasonable with its use of debt. This means that they are taking a bit more risk, in the hope of increasing shareholder returns. When analyzing debt levels, the balance sheet is the obvious place to start. But at the end of the day, every business can contain risks that exist off the balance sheet. Note that SSAB displays 1 warning sign in our investment analysis , you must know…
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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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 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 documents. Simply Wall St has no position in any of the stocks mentioned.