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.' 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. We can see that Hemfosa Fastigheter AB (publ) (STO:HEMF) 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for Hemfosa Fastigheter
How Much Debt Does Hemfosa Fastigheter Carry?
The image below, which you can click on for greater detail, shows that Hemfosa Fastigheter had debt of kr23.4b at the end of June 2019, a reduction from kr27.2b over a year. However, because it has a cash reserve of kr683.0m, its net debt is less, at about kr22.7b.
A Look At Hemfosa Fastigheter's Liabilities
The latest balance sheet data shows that Hemfosa Fastigheter had liabilities of kr1.16b due within a year, and liabilities of kr25.3b falling due after that. Offsetting these obligations, it had cash of kr683.0m as well as receivables valued at kr238.0m due within 12 months. So its liabilities total kr25.6b more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the kr15.2b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Hemfosa Fastigheter would likely require a major re-capitalisation if it had to pay its creditors today.
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.