Legendary fund manager Lee Lou (backed by Charlie Monger) once said, ‘The biggest investment risk is not price volatility, but whether it will suffer from a permanent capital loss’. When we think about the degree of risk of a company, we always like to look at its use of debt, since debt overload can lead to destruction. As in many other companies Akzo Nobel NV (AMS: AKZA) Uses debt. But should shareholders be concerned about its use of debt?
What risk does debt bring?
The debt helps the business until the business has difficulty paying it off, whether in new capital or in free cash flow. Ultimately, if the company is unable to meet its legal obligations to repay a debt, shareholders can get out of there with nothing. However, a more common (but still expensive) phenomenon is where a company must issue shares at bargain prices, which permanently dilutes shareholders, just to strengthen its balance sheet. However, the most common situation is where a company manages its debt reasonably – and for its own benefit. When we think of a company’s use of debt, we first look at cash and debt together.
See our latest analysis for Akzo Nobel
How much debt does Exo Noble carry?
The image below, which you can click on for more details, shows that in September 2021, Exo Noble had a debt of 3.08 billion euros, an increase from 2.93 billion euros in one year. However, it also had 1.10 billion euros in cash, so its net debt is 1.98 billion euros.
How strong is the balance of Exo Noble?
According to the latest balance sheet, Exo Noble had commitments of € 4.41 billion to be repaid within 12 months, and commitments of € 3.33 billion to be repaid over 12 months. In offsetting these liabilities, it had cash of € 1.10 billion as well as debt of € 2.38 billion to be repaid within 12 months. So its liabilities total € 4.25 billion more than the combination of cash and short-term debt.
This deficit is not so bad that Exo Noble is worth a whopping € 17.5 billion, and can therefore probably raise enough capital to strengthen its balance sheet, should the need arise. But we certainly want to open our eyes to indications that his debt brings too much risk.
In order to increase a company’s debt relative to its profits, we calculate its net debt parts of its profit before interest, tax, depreciation and amortization (EBITDA) and its profit before interest and tax (EBIT) divided by its interest expenses (its interest coverage). Thus, we see both the absolute amount of the debt as well as the interest paid on it.
Exo Noble has a net debt to EBITDA ratio of only 1.4. And its EBIT covers its interest expenses a whopping 19.8 times huge. So you can argue that he is no more threatened by his debt than an elephant threatened by a mouse. Another good sign is that Exo Noble has managed to increase its EBIT by 28% within 12 months, making it easier to repay the debt. When analyzing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will determine whether Exo Noble can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analysts’ earnings forecasts interesting.
Finally, while the taxman may admire accounting profits, lenders only receive cold cash. So the logical step is to look at the rate of that EBIT that corresponds to the actual free cash flow. Over the past three years, Exo Noble has generated a stable free cash flow equal to 56% of its EBIT, about what we would expect. This cold hard cash means he can reduce his debt whenever he wants.
The good news is that Exo Noble’s demonstrated ability to cover its interest expenses with its EBIT makes us as happy as a shivering puppy does. And the good news does not stop there, as the growth rate of its EBIT also supports this impression! Looking at the bigger picture, we think the use of Exo Noble in debt seems quite reasonable and we are not worried about it. After all, logical leverage can increase returns on capital. There is no doubt that we learn the most about debt from the balance sheet. But in the end, any company can take risks that exist off-balance sheet. For example, we identified One warning sign for Exo Noble That you need to be aware of.
If, after all this, you are more interested in a fast growing company with a solid balance sheet, check out our list of Net Cash Growth Stocks Without Delay.
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This article by Simply Wall St is general in nature. We provide interpretation based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended for financial advice. It does not constitute a recommendation to buy or sell any stock, nor does it take into account your goals, or your financial situation. We strive to bring you focused long-term analysis driven by basic data. Please note that our analysis may not take into account the latest postings of the company that are sensitive to price or quality material. Simply Wall St has no position in any of the stocks mentioned.