Is Epiroc (STO:EPI A) a risky investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We can see that Epiroc AB (publisher) (STO:EPI A) uses debt in its business. But should shareholders worry about its use of debt?

When is debt dangerous?

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. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. 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. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first step when considering a company’s debt levels is to consider its cash and debt together.

Check out our latest analysis for Epiroc

What is Epiroc’s debt?

As you can see below, Epiroc had a debt of 9.32 billion kr in March 2022, compared to 10.1 billion kr the previous year. But he also has 11.2 billion kr in cash to offset this, which means he has a net cash of 1.89 billion kr.

OM:EPI A Debt to Equity History May 16, 2022

How strong is Epiroc’s balance sheet?

Zooming in on the latest balance sheet data, we can see that Epiroc had liabilities of 13.5 billion kr due within 12 months and liabilities of 10.1 billion kr due beyond. In return, he had 11.2 billion kr in cash and 10.8 billion kr in debt due within 12 months. It therefore has liabilities totaling kr 1.56 billion more than its cash and short-term receivables, combined.

This situation indicates that Epiroc’s balance sheet looks quite strong, as its total liabilities roughly equal its liquid assets. So while it’s hard to imagine the company struggling to find cash, we still think it’s worth monitoring its balance sheet. While it has liabilities worth noting, Epiroc also has more cash than debt, so we’re pretty confident it can manage its debt safely.

Another good sign, Epiroc was able to increase its EBIT by 28% in twelve months, thus facilitating the repayment of debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine Epiroc’s ability to maintain a healthy balance sheet in the future. 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. Epiroc may have net cash on the balance sheet, but it’s always interesting to see how well the company converts its earnings before interest and tax (EBIT) into free cash flow, as this will influence both its need and its ability to manage debt. Over the past three years, Epiroc has recorded free cash flow of 80% of its EBIT, which is higher than what we would normally expect. This puts him in a very strong position to pay off the debt.

Summary

While it is always a good idea to look at a company’s total liabilities, it is very reassuring that Epiroc has 1.89 billion kr in net cash. The icing on the cake was to convert 80% of this EBIT into free cash flow, which brought in 5.6 billion kr. We therefore do not believe Epiroc’s use of debt is risky. 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 outside of the balance sheet. For example, we found 1 warning sign for Epiroc which you should be aware of before investing here.

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% freeright now.

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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