Is Lifco (STO:LIFCO B) a risky investment?

Howard Marks said 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 that every practical investor that I know is worried”. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Like many other companies Lifco AB (publisher) (STO:LIFCO B) uses debt. But the more important question is: what risk does this debt create?

When is debt dangerous?

Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. If things go really bad, lenders can take over the business. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business has is to look at its cash and debt together.

Check out our latest analysis for Lifco

What is Lifco’s debt?

The image below, which you can click on for more details, shows that in March 2022, Lifco had a debt of 6.36 billion kr, compared to 5.12 billion kr in one year. However, he also had 1.47 billion kr in cash, so his net debt is 4.88 billion kr.

OM:LIFCO B Debt to Equity History May 3, 2022

A look at Lifco’s responsibilities

According to the latest published balance sheet, Lifco had liabilities of kr 9.08 billion maturing within 12 months and liabilities of kr 6.16 billion maturing beyond 12 months. On the other hand, it had a cash position of 1.47 billion kr and 3.21 billion kr of receivables due within one year. Thus, its liabilities total kr 10.6 billion more than the combination of its cash and short-term receivables.

Given that Lifco has a market capitalization of 88.7 billion kr, it is hard to believe that these liabilities pose a threat. However, we think it’s worth keeping an eye on the strength of its balance sheet, as it can change over time.

We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

Lifco has a low net debt to EBITDA ratio of just 1.2. And its EBIT covers its interest charges 51.6 times. So we’re pretty relaxed about his super-conservative use of debt. On top of that, Lifco has grown its EBIT by 39% over the last twelve months, and this growth will make it easier to manage its debt. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine Lifco’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Lifco has recorded free cash flow of 89% of its EBIT, which is higher than what we would normally expect. This puts him in a very strong position to repay his debt.

Our point of view

The good news is that Lifco’s demonstrated ability to cover its interest charges with its EBIT delights us like a fluffy puppy does a toddler. And this is only the beginning of good news since its conversion of EBIT into free cash flow is also very pleasing. Overall, we don’t think Lifco is taking bad risks, as its leverage looks modest. So we are not worried about using a little leverage on the balance sheet. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example – Lifco has 2 warning signs we think you should know.

In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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