These 4 measurements indicate that Nolato (STO: NOLA B) is using his debt safely
Legendary fund manager Li Lu (whom Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the fact that you suffer a permanent loss of capital. 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. We notice that Nolato AB (released) (STO: NOLA B) has debt on its balance sheet. But does this debt worry shareholders?
What risk does debt entail?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, many companies use debt to finance their growth without negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
Check out our latest analysis for Nolato
What is Nolato’s net debt?
The image below, which you can click for more details, shows that in March 2021, Nolato was in debt of Kroner 1.75 billion, compared to Kroner 732.0 million in a year. However, he also had 1.56 billion crowns in cash, so his net debt is 187.0 million crowns.
How strong is Nolato’s balance sheet?
We can see from the most recent balance sheet that Nolato had debt of KKr 3.50 billion due within one year and KKr 1.90 billion debt beyond. On the other hand, he had a treasury of 1.56 billion crowns and 1.43 billion crowns of debts due within one year. It therefore has liabilities totaling 2.41 billion crowns more than its combined cash and short-term receivables.
Of course, Nolato has a market cap of 24.7 billion crowns, so those liabilities are probably manageable. Having said that, it is clear that we must continue to monitor his record lest it get worse. But anyway, Nolato has virtually no net debt, so it’s fair to say he doesn’t have a lot of debt!
We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt over EBITDA) and the actual interest charges associated with this debt (with its interest coverage rate). ).
Nolato’s net debt is only 0.12 times its EBITDA. And its EBIT covers its interest costs 146 times more. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Also positive, Nolato has increased its EBIT by 24% over the past year, which should make it easier to repay debt going forward. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Nolato can strengthen its balance sheet over time. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Nolato has recorded free cash flow of 72% of its EBIT, which is close to normal given that free cash flow excludes interest and taxes. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
The good news is that Nolato’s demonstrated ability to cover his interest costs with his EBIT delights us like a fluffy puppy does a toddler. And the good news does not end there, since its net debt to EBITDA also confirms this impression! Overall, we don’t think Nolato is taking bad risks, as his leverage appears modest. We are therefore not worried about the use of a small leverage on the balance sheet. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. We have identified 2 warning signs with Nolato and understanding them should be part of your investment process.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.
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