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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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, UPM-Kymmene Oyj (HEL:UPM) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for UPM-Kymmene Oyj
What Is UPM-Kymmene Oyj's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 UPM-Kymmene Oyj had €1.26b of debt, an increase on €957.0m, over one year. However, because it has a cash reserve of €769.0m, its net debt is less, at about €495.0m.
How Strong Is UPM-Kymmene Oyj's Balance Sheet?
According to the last reported balance sheet, UPM-Kymmene Oyj had liabilities of €1.92b due within 12 months, and liabilities of €2.62b due beyond 12 months. On the other hand, it had cash of €769.0m and €1.85b worth of receivables due within a year. So its liabilities total €1.93b more than the combination of its cash and short-term receivables.
Given UPM-Kymmene Oyj has a humongous market capitalization of €13.4b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
UPM-Kymmene Oyj has a low net debt to EBITDA ratio of only 0.28. And its EBIT covers its interest expense a whopping 68.0 times over. So we're pretty relaxed about its super-conservative use of debt. Fortunately, UPM-Kymmene Oyj grew its EBIT by 2.1% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if UPM-Kymmene Oyj can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.