Warren Buffett said: “Volatility is far from synonymous with risk. 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 OEM International AB (published) (STO:OEM B) uses debt in its business. But the more important question is: what risk does this debt create?
When is debt a problem?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. 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, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.
See our latest analysis for OEM International
What is OEM International’s net debt?
You can click on the graph below for historical figures, but it shows that in September 2021, OEM International had a debt of 131.0 million kr, an increase from 101.0 million kr, on a year. On the other hand, he has 122.0 million kr in cash, resulting in a net debt of around 9.00 million kr.
How strong is OEM International’s balance sheet?
The latest balance sheet data shows that OEM International had liabilities of kr 543.0 million falling due within one year, and liabilities of kr 130.0 million falling due thereafter. As compensation for these obligations, it had liquid assets of 122.0 million kr as well as receivables valued at 637.0 million kr and payable within 12 months. So he actually has 86.0 million kr Continued liquid assets than total liabilities.
This indicates that OEM International’s balance sheet looks quite strong, as its total liabilities roughly equal its cash. It is therefore very unlikely that the 11.5 billion kr company will run out of cash, but it is still worth keeping an eye on the balance sheet. But regardless, OEM International has virtually no net debt, so it’s fair to say that it’s not heavily indebted!
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). Thus, we consider debt to earnings with and without amortization and depreciation expense.
With debt at a measly 0.016 times EBITDA and EBIT covering 586 times interest, it’s clear that OEM International is not a desperate borrower. Indeed, relative to its earnings, its leverage seems light as a feather. On top of that, OEM International has grown its EBIT by 38% over the last twelve months, and this growth will make it easier to manage its debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is OEM International’s earnings that will influence the balance sheet in the future. So, if you want to know more about its earnings, it might be worth checking out this graph of its long-term trend.
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, OEM International has produced strong free cash flow equivalent to 75% of its EBIT, which is what we expected. This cold hard cash allows him to reduce his debt whenever he wants.
Our point of view
Fortunately, OEM International’s impressive interest coverage means it has the upper hand on its debt. And the good news does not stop there, since its EBIT growth rate also confirms this impression! We believe that OEM International is no more indebted to its lenders than birds are to birdwatchers. In our view, he has a healthy and happy record. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. We have identified 2 warning signs with OEM International, and understanding them should be part of your investment process.
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.
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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.
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