These 4 metrics indicate that Strax (STO:STRAX) is using debt in a risky way

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David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Above all, Strax AB (ed.) (STO:STRAX) is in debt. 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. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. 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. Of course, many companies use debt to finance their growth, without any negative consequences. When we think about a company’s use of debt, we first look at cash and debt together.

Check out our latest analysis for Strax

What is Strax’s debt?

The image below, which you can click on for more details, shows that in March 2022, Strax had a debt of 49.3 million euros, compared to 34.0 million euros in one year. However, he has €3.02m in cash to offset this, resulting in a net debt of around €46.3m.

OM:STRAX Debt to Equity History August 26, 2022

How healthy is Strax’s balance sheet?

We can see from the most recent balance sheet that Strax had liabilities of 91.0 million euros due in one year, and liabilities of 5.41 million euros due beyond. In return, it had 3.02 million euros in cash and 24.6 million euros in receivables due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables by €68.8 million.

This deficit casts a shadow over the 21.9 million euro company, like a colossus towering above mere mortals. So we definitely think shareholders need to watch this one closely. After all, Strax would likely need a major recapitalization if it were to pay its creditors today.

We measure a company’s leverage against its earning power 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 charge (interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.

Low interest coverage of 0.37x and an extremely high net debt to EBITDA ratio of 16.3 shook our confidence in Strax like a punch in the gut. This means that we would consider him to be heavily indebted. Worse still, Strax’s EBIT is down 70% from a year ago. If profits continue like this in the long term, there is an unimaginable chance of repaying this debt. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Strax can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

Finally, a company can only repay its debts with cold hard cash, not with book profits. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Strax has had substantial negative free cash flow, in total. While investors no doubt expect a reversal of this situation in due course, this clearly means that its use of debt is more risky.

Our point of view

To be frank, Strax’s EBIT growth rate and track record of keeping total liabilities under control makes us rather uncomfortable with its level of leverage. And even his coverage of interests does not inspire much confidence. It seems to us that Strax carries a heavy burden on the balance sheet. If you play with fire, you might get burned, so we’d probably give this stock a wide berth. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. Know that Strax shows 2 warning signs in our investment analysis and 1 of them makes us a little uncomfortable…

If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.

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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