Does Garo Aktiebolag (STO:GARO) Have A Healthy Balance Sheet?

Simply Wall St

Wed, Aug 28, 2019, 11:25 PM

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Garo Aktiebolag (publ) (STO:GARO) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Garo Aktiebolag

What Is Garo Aktiebolag's Debt?

As you can see below, at the end of June 2019, Garo Aktiebolag had kr109.4m of debt, up from kr101.2m a year ago. Click the image for more detail. On the flip side, it has kr7.10m in cash leading to net debt of about kr102.3m.

OM:GARO Historical Debt, August 29th 2019

How Strong Is Garo Aktiebolag's Balance Sheet?

The latest balance sheet data shows that Garo Aktiebolag had liabilities of kr271.5m due within a year, and liabilities of kr71.5m falling due after that. On the other hand, it had cash of kr7.10m and kr233.4m worth of receivables due within a year. So its liabilities total kr102.5m more than the combination of its cash and short-term receivables.

Since publicly traded Garo Aktiebolag shares are worth a total of kr2.73b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Garo Aktiebolag has net debt of just 0.77 times EBITDA, suggesting it could ramp leverage without breaking a sweat. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So it's fair to say it can handle debt like a hot shot teppanyaki chef handles cooking. Also good is that Garo Aktiebolag grew its EBIT at 19% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Garo Aktiebolag'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Garo Aktiebolag's free cash flow amounted to 32% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Happily, Garo Aktiebolag's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. Taking all this data into account, it seems to us that Garo Aktiebolag takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Garo Aktiebolag insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.

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