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. We can see that Leroy Seafood Group ASA (OB:LSG) uses debt in its business. But the more important question is: what risk does this debt create?
What risk does debt carry?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. If things go really bad, lenders can take over the business. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. 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 step when considering a company’s debt levels is to consider its cash and debt together.
Check out our latest analysis for Lerøy Seafood Group
How much debt does Lerøy Seafood Group have?
The image below, which you can click on for more details, shows that in March 2022, Lerøy Seafood Group had a debt of 5.94 billion kr, compared to 4.98 billion kr in one year. However, since he has a cash reserve of 3.84 billion kr, his net debt is lower at around 2.10 billion kr.
How strong is Lerøy Seafood Group’s balance sheet?
According to the latest published balance sheet, Lerøy Seafood Group had liabilities of 4.79 billion kr due within 12 months and liabilities of 10.2 billion kr due beyond 12 months. In compensation for these obligations, it had cash of 3.84 billion kr as well as receivables valued at 2.96 billion kr and payable within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of 8.22 billion kr.
Given that publicly traded Lerøy Seafood Group shares are worth a total of 43.8 billion kr, it seems unlikely that this level of liability is a major threat. That said, it is clear that we must continue to monitor its record, lest it deteriorate.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
Lerøy Seafood Group has a low net debt to EBITDA ratio of just 0.46. And its EBIT covers its interest charges 17.3 times. So we’re pretty relaxed about his super-conservative use of debt. Even better, Lerøy Seafood Group increased its EBIT by 130% last year, which is an impressive improvement. If sustained, this growth will make debt even more manageable in years to come. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Lerøy Seafood Group 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 taxman may love accounting profits, lenders only accept cash. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Lerøy Seafood Group has recorded free cash flow of 75% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This cold hard cash allows him to reduce his debt whenever he wants.
Our point of view
Lerøy Seafood Group’s interest coverage suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. And the good news does not stop there, since its EBIT growth rate also confirms this impression! Considering this set of factors, it seems to us that Lerøy Seafood Group is quite cautious with its debt, and the risks seem well controlled. 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. These risks can be difficult to spot. Every business has them, and we’ve spotted 1 warning sign for Lerøy Seafood Group you should know.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.
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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.