Howard Marks put it well when he said that, rather than worrying about stock price volatility, “The possibility of permanent loss is the risk that worries me … and every investor practices that I know worries “. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Like many other companies ICA Gruppen AB (released) (STO: ICA) 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. However, a more common (but still painful) scenario is that he must raise new equity at low cost, thereby diluting shareholders over the long term. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we think of a business’s use of debt, we first look at cash flow and debt together.
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What is ICA Gruppen’s net debt?
The image below, which you can click for more details, shows that ICA Gruppen was in debt of SEK 6.55 billion at the end of March 2021, down from SEK 7.18 billion. over a year. However, it has 6.44 billion crowns of cash offsetting this, which leads to a net debt of around 106.0 million crowns.
How healthy is ICA Gruppen’s balance sheet?
Zooming in on the latest balance sheet data, we can see that ICA Gruppen had a liability of kr 45.0 billion due within 12 months and a liability of kr 25.0 billion due thereafter. In compensation for these obligations, it had cash of 6.44 billion crowns as well as claims valued at 3.10 billion crowns within 12 months. Its liabilities therefore total 60.5 billion crowns more than the combination of its cash and short-term receivables.
This is a mountain of leverage compared to its market cap of SEK 79.5 billion. This suggests that shareholders would be heavily diluted if the company needed to consolidate its balance sheet quickly. But anyway, ICA Gruppen has virtually no net debt, so it’s fair to say that it doesn’t have heavy debt!
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 profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
ICA Gruppen has very little debt (net of cash) and has a debt / EBITDA ratio of 0.015 and an EBIT of 12.6 times interest expense. Compared to past profits, debt therefore seems insignificant. The good news is that ICA Gruppen increased its EBIT by 4.4% year-over-year, which should allay concerns about debt repayment. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether ICA Gruppen can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Fortunately for all shareholders, ICA Gruppen has actually generated more free cash flow than EBIT over the past three years. This kind of solid money conversion makes us as excited as the crowd when the beat drops at a Daft Punk concert.
Our point of view
Fortunately, ICA Gruppen’s impressive interest coverage means that it has the upper hand over its debt. But frankly, we think his total passive level undermines that feeling a bit. Looking at all of the aforementioned factors together, it seems to us that ICA Gruppen can manage her debt quite comfortably. On the plus side, this leverage can increase returns for shareholders, but the potential downside is more risk of loss, so it’s worth watching the balance sheet. The balance sheet is clearly the area you need to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. For example, we have identified 1 warning sign for ICA Gruppen of which you should be aware.
If you are interested in investing in companies that can generate profits without the burden of debt, check out this page free list of growing companies that have net cash on the balance sheet.
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